Suppose the economy is in a long-run equilibrium when a ...

[xclash]

Suppose the economy is in a long-run equilibrium when a temporary, favorable aggregate supply shock occurs. On the graphs above, show what happens to bring the economy back to long-run equilibrium, assuming that there is no policy response.
 
  In words, explain why no response is the best policy.

Question 2

The mathematicians and economists who have been hired by Wall Street firms to build mathematical models to aid the pricing of derivatives are generally referred to as
 
  A) speculators.
  B) hedgers.
  C) rocket scientists.
  D) market makers.

[chloejackso]

Answer to Question 1

The graphs should be similar to Fig. 13.6, with AS shifting first right and then back to the left, so inflation returns to its original rate. If policy makers respond when the inflation rate falls below target, the output gap is enlarged, so AS will shift up and cause a positive inflation gap. If the policy response is to correct the output gap, the decrease in AD will enlarge the negative inflation gap. With no policy response, both the output and inflation gaps return to zero.

Answer to Question 2

C