3. Equilibrium P SAS LAS P* AD Y Y* Yf

4.a. Aggregate demand P SAS LAS AD0 -> AD1 => P Y => unemployment decreases but inflation increases AD1 AD0 AD2 P1 AD0 -> AD2 => P Y => unemployment increases but inflation decreases P0 P2 Y Y2 Y0 Y1 Yf

4.a.(2)(a) Monetary policy SAS LAS AD0 -> AD1 => P Y => unemployment decreases but inflation increases AD1 AD0 Use contractionary monetary policy to deal with the problem of inflation AD2 P1 AD0 -> AD2 => P Y => unemployment increases but inflation decreases P0 P2 Use expansionary monetary policy to deal with the problem of unemployment Y Y2 Y0 Y1 Yf

Effectiveness of monetary policy IRE IRE IRE0 IRE1 IRE IRE0 IRE1 IRE

4.a.(2)(b) Fiscal policy P SAS LAS AD0 -> AD1 => P Y => unemployment decreases but inflation increases AD1 AD0 Use contractionary fiscal policy to deal with the problem of inflation AD2 P1 AD0 -> AD2 => P Y => unemployment increases but inflation decreases P0 P2 Use expansionary fiscal policy to deal with the problem of unemployment Y Y2 Y0 Y1 Yf

4.a.(2)(b) i) Crowding out r MS0 MS1 r MD1 IRE MD0 M IRE r1 r1 r0 r0

b. Short-run aggregate supply SAS1 P SAS0 LAS Resource costs increase: SAS0 -> SAS1 => P Y => unemployment increases and inflation increases Worst possible situation: P1 - Using expansionary policy to deal with unemployment makes inflation worse P0 AD - Using contractionary policy to deal with inflation makes unemployment worse Y Y1 Y0 Yf

c. Long-run aggregate supply SAS LAS0 SAS LAS1 More resources, more efficient use of resources, improved technology => economic growth SAS0 -> SAS1 => P Y P0 => unemployment decreases and inflation decreases P1 AD Y Y0 (Yf)0 Y1 (Yf)1

5. Business cycle Y Time Peak Recession Expansion Turning points Trough Time