AP Macro · Unit 4 · Financial Sector

After a collapse in business confidence, Calderra's real GDP has fallen to $610 billion, below its full-employment real GDP of $650 billion, and its unemployment rate has risen to 7.5 percent. The banking system in Calderra has limited reserves.

(a) Draw a correctly labeled graph of aggregate demand, short-run aggregate supply, and long-run aggregate supply for Calderra, and show each of the following.

• (i) The current equilibrium real output and price level, labeled $Y_1$ and $PL_1$, respectively

• (ii) The full-employment output, labeled $Y_F$
  (b) Identify the open-market operation the central bank of Calderra could use to help the economy recover from the recession.
  (c) Draw a correctly labeled graph of the money market for Calderra, and label the current equilibrium nominal interest rate $i_1$.
  (d) On your graph in part (c), show the effect of the open-market operation identified in part (b). Label the new nominal interest rate $i_2$.
  (e) Based on the change in the nominal interest rate shown in part (d), what will happen to real output in Calderra in the short run? Explain.
  (f) Based on your answer in part (e), will the price level in Calderra increase, decrease, or remain the same in the short run?