Suppose that firms become more optimistic about their future profits. Using the AD-AS model (with a Keynesian perspective), answer the following questions.
a. In the absence of any policy intervention, what will happen to prices and output over the short- and long-run? What will happen to real interest rates in the long run?
b. Taking an activist (Keynesian) approach, show how one can use fiscal policy to return the economy to full employment. Would taxes be increased or decreased? How about government spending? If these policies were implemented, what would happen to interest rates?
c. Repeat part (b) for monetary policy. Would the Federal Reserve make an open market purchase or sale? If these policies were implemented, what would happen to interest rates?