Suppose that investors become more optimistic about the housing market and purchases of new homes increase. 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-run 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? What would happen to interest rates in this case?