Reference no: EM132639989

Let us consider the country of Wolverinistan, a closed economy that starts off in a long-run equilibrium. Recently two things have happened in this country: (1) the central bank decides to pursue a more expansionary monetary policy (i.e., they increase the growth rate of money), and (2) new tax laws make big capital investments by companies more attractive.

a) What sort of open market operation would the central bank use to undertake this expansionary policy? (I.e., would they be buying or selling bonds?)

b) Draw the AD-AS diagram like we did in class. Label the initial long-run equilibrium starting point. You should have three curves on your diagram. In the short-run, indicate how these two shocks would shift the curves in the diagram as well as what you predict would happen (again in the short run) to the level of GDP and the price level.

c) Assume that the changes described in the set-up to the problem persist for a long period of time and that there are no other shocks. In the long run, what will happen to real GDP and to prices? Indicate the results on your diagram.

d) In the VERY long run (hint: Solow model!), how will these changes effect the level of output per capita? How will these changes effect the growth rate of output per capita? Why?