Suppose the economy is in a long-run equilibrium when the government increases spending on defense.
a. Draw an aggregate demand/supply diagram that illustrates the short-run effect of this increase.
b. In the short run, what happens to the price level and the level of output?
c. Now, draw an aggregate demand/supply diagram that illustrates both the long-run and the short-run effect of this increase if the government does not use any other policy action.
d. In the long run, what happens to the price level and the level of output?
e. Now, suppose the Fed responds by increasing the reserve requirement, draw an aggregate demand/supply diagram that illustrates both the long-run and the short-run effect.
f. What happens to the price level and the level of output in the long-run?