Let’s imagine a scenario where the US economy is grappling with high unemployment rates.

a. Visualize a graph with aggregate demand, supply, and long-run aggregate supply curves that reflect this high unemployment scenario. Mark the current price level and output as PL and Y1 respectively. Also, denote the full employment output level as Yf.

b. Now, suppose the economy is facing a recessionary gap of $50 million. The government decides to implement an expansionary fiscal policy to combat this.

i) If the Marginal Propensity to Consume (MPC) is 0.5, what should be the reduction in government spending to bridge this gap?

ii) Alternatively, how much should the government increase taxes to achieve the same effect?

iii) Now, consider a graph of the loanable funds market. Show the effect of government borrowing on real interest rates. Can you explain the changes that will occur in the real interest rates?

c. If the Federal Reserve Bank decides to infuse money into the market, which expansionary open-market operation should it employ?

d. Now, using a money market graph, illustrate the impact of the open-market operation used in part © on the money supply and interest rates.

e. Finally, what would be the effect of the action in part (d) on the price level and Gross Domestic Product (GDP)?