Assume the Economy Is Initially in a Short-Run Equilibrium at a Level

Essay

Assume the economy is initially in a short-run equilibrium at a level of output below the natural rate.
a. Use the IS-LM model to graphically illustrate: (1) how the economy will adjust in the long-run if the no policy action is taken; and (2) the long-run equilibrium if fiscal policy is used to return the economy to the natural rate of output.
b. Explain how investment, the interest rate, and the price level differ in the new long-run equilibrium in the two cases.