(03.01–03.09 HC)

For all graphs, be sure to correctly and completely label all axes and curves and use arrows to indicate the direction of any shifts. (10 points)

Assume Spain is currently operating with a high cyclical unemployment rate.

Draw a correctly labeled graph of the long-run aggregate supply, short-run aggregate supply, and aggregate demand curves.
Label the equilibrium price level PL1 and the equilibrium real output Y1.
Label the full-employment level of output YF.
Where on a production possibilities curve representing full employment in Spain would current output be—on, outside, or inside the PPC?
What can be assumed about inflation based on the information above?
Assume that the output gap is estimated to be $100 billion and the government decides to take action. If the marginal propensity to consume is 0.9, by how much would it need to change government spending to close the gap? Show your work.
If instead, government chose to use the income tax to close the output gap rather than changes in spending, calculate the change in tax revenue the government would need to close the gap. Assume the same figures as part (d).
What is one possible automatic stabilizer in the economy that would contribute to closing this output gap?
Assume that instead of intervening, the government allowed the economy to self-adjust in the long run. On your graph from part (a), illustrate how the economy would self-adjust in the long run.
If the GDP deflator is 110 in the year that the output gap is identified, and three years later it is 105, does this mean the recessionary gap is likely gone or that it still exists? Explain.