a. Assume initially that the economy is in a state of long-run equilibrium. The real GDP equals potential GDP and only natural unemployment exists. Now suppose that consumer confidence plummets and the aggregate demand decreases. What will happen to the general price level (P) and the real GDP (Y) in the short run? Why? What will happen to P and Y in the long run? Why? Describe the process of self-correcting mechanism from the beginning to the end.
b. After the aggregate demand decreases in part “a” above, what kind of a demand-management policy would a typical liberal economist propose, an active policy or do nothing? How about a conservative economist? What justifications would they provide for their respective proposed policies?
c. In general, how does an expansionary monetary policy work? (Describe the steps through which an increase in money supply affects the real GDP).
d. In general, how does fiscal policy work? (Describe the steps through which an increase in G or TR, or a decrease in TX, affects the real GDP).
e. What are the advantages and disadvantages of using an expansionary monetary policy in a recession compared to using fiscal policy? (Please note: I am not asking you how monetary policy works. You have already answered it in part c above. The question is specifically about the advantages of monetary policy compared fiscal policy in a recession).
f. What are the advantages and disadvantages of using an expansionary fiscal policy in a recession (That is, compared to using monetary policy)?
