1. Unit #3 Key Graphs AS/AD Model PPF

2. Practice Free Response Answers

3. QUESTION #1 1b) Prices & Wages are sticky in the short run. So quantity supplied rises and falls as the price level rises or fall (positive relationship) Example: Price Level ↑  => Nominal Wages unchanged but Real Wages ↓ => So Qty Supplied rises  1c) Actual Price level at (P1) is LOWER than expected price level (which lags!) Expected price level lags actual price level in both directions (actual price level is the one you are graphing => so if AD shifts left => actual falls immediately…) 1d) Expected price level eventually falls to “catch up” to actual price level => SRAS shifts right to full employment output level (E 2 ) 1a) SRAS2 ----------------- P2 E2

4. QUESTION #2 2b) Contractionary Fiscal Policy 2c) Raise income taxes => (C↓) Decrease Gov’t Spending => (G↓ ) Gov’t Budget=> Gov’t revenue ↑ & Gov’t Spending ↓ So overall, deficit shrinks. Could lead to balanced budget or budget surplus in the extreme End result: AD shifts left, deficit falls, output returns to full potential (on PPF), 2d) unemployment ↑ price level ↓ R-GDP ↓ 2 a,d) AD 2 -------- Y2Y2 P2P2 E2E2

5. S2S2 QUESTION #3 3c) Public savings rises (becomes less negative) so National Savings ↑  So Loanable Funds Supply Shifts Right 3d) AD shift is indeterminate: G ↓ (Gov’t spending ↓) => AD left BUT Lower real interest rates => increase in Investment ( I↑ ) AD right 3e) Increase in Investment ( I↑ ) today mean in the long run: PPF: Capital Investment shifts PPF to right in long run SRAS & LRAS: both shift right as PPF went right UNEMPLOYMENT: r-GDP rises => unemployment rate must fall 3c) graph 3a) Demand Curve = Investors (business) Investors borrow money for capital goods to expand business… ------------------ Q2Q2 r2r2 --------- E2E2