Question 4)
• Consider a baseline long run steady state
•
equilibrium where output is 22 trillion dollars, and the price level is 100. Note: price expectation is the same as the price level at the long run steady state equilibrium & unemployment is 5% or lower
Starting from the baseline, suppose COVID 19 hits this economy. If this disease only makes workers sick (everything else remaining constant) can you show how would the long run steady state equilibrium will be disrupted & what policies can be taken to stop the market adjustment?
• You should answer in the following steps
Answer 4)
Steps
Step 1) What happens in the short run to equilibrium price level and aggregate quantity & why? (Think about which curve shifts in which direction and why & where is the new short run equilibrium?)
Step 2) What happens to the initial equality between price level and price expectations because of COVID19?
Step 3) What happens to price expectations in the long run? (The market adjustment phase)
Step 4) What happens next in the market adjustment phase? (Think about which curve shifts in which direction and why & where is the new short run equilibrium?)
Step 5) What policies (you have to say who takes these policies; congress/federal reserve) will be taken to stop the market adjustment from kicking in?
Your Answers