Using aggregate demand and aggregate supply, explain what happens ...

[cherise1989]

Using aggregate demand and aggregate supply, explain what happens in the short run if the Federal Reserve raises interest rates in the economy. Be sure to detail what happens to aggregate demand, the price level, the level of GDP, and unemployment.
 
  Assume that the economy is at full employment before the interest rate increase.

Question 2

The passage of the Smoot-Hawley Tariff in 1930 sparked a trade war that caused net exports to ________ and real GDP to ________.
 
  A) decrease; increase B) increase; increase C) decrease; decrease D) increase; decrease

[CAPTAINAMERICA]

Answer to Question 1

An increase in the interest rate will cause aggregate demand to decline. Interest costs are part of the cost of borrowing and as they rise, both firms and households will cut back on spending. This shifts the aggregate demand curve to the left. This lowers equilibrium GDP below potential GDP. As production falls for many firms, they begin to lay off workers, and unemployment rises. The declining demand also lowers the price level. The economy is in recession.

Answer to Question 2

C

[cherise1989]

Excellent

[mcarey591]

TYSM