Problem
Consider the AD-AS model discussed during the lectures. Assume that the aggregate demand curve is given by Y=8-0.5 π, that the long run aggregate supply curve is given by Yp=7, that the short run aggregate supply curve is given by π = π_expect + 0.3(Y-Yp), and that the monetary rule is given by r=1+0.3 π.
1. What is the economic interpretation behind the short run aggregate supply curve? Why is it positively sloped? How does it relate to the unemployment rate?
2. Suppose the economy is in equilibrium at the potential level of output, with inflation expectations equal to actual inflation, which equals 2%. As a change in business sentiments, autonomous investments suddenly decrease. Use the model to interpret what happens in the short run and in the long run if the central bank does not intervene exogenously with an expansionary monetary policy.
3. Suppose the economy is suffering a decrease in the potential level of output, due to some ill-designed new regulation. According to the AD-AS model, what is more suitable to offset the subsequent decline in output, an expansionary monetary policy or an expansionary fiscal policy?