Real gdp and the price level

1. Draw a diagram which includes the AD, SRAS and LRAS curves to illustrate this situation. Show the output gap – is it a recessionary or an inflationary gap? Both axis, the output gap and all curves must be clearly labelled. (2 marks)

2. Discuss 3 fiscal policy options available to the government to try moving the economy back to long-run macroeconomic equilibrium. Which of these policy options would be most effective in closing the output gap and why? Illustrate the effects of the appropriate fiscal policy on real GDP and the price level in your diagram. If you shift a curve, clearly show the direction of shift using an arrow. (5 marks)

Part B – The Foreign Exchange Market (7 Marks)

1. Canada is a net exporter of oil to the U.S., and as you know the world price of oil has fallen recently. Explain why the lower oil price has resulted in a depreciation of the Canadian dollar against the U.S. dollar. Given that the demand for Canadian oil from the U.S. continues to rise, wouldn’t we expect an increase in the demand for Canadian dollars, causing an appreciation of our dollar? (hint: consider the elasticity of demand for oil)

Part C – The Monetary System and Monetary Policy: Chapters 10 & 15 (11 Marks)

1. Suppose the Bank of Canada believes that the Canadian economy is currently producing beyond its potential level of output and responds with contractionary monetary policy. However, the Bank has underestimated the level of potential output and the economy is actually in long-run macroeconomic equilibrium (8 marks)