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Capacity utilization

1. Suppose that the economy is currently in a recession. If policy-makers take no action, how will the economy evolve over time? Explain in words and using an aggregate-demand/ aggregate-supply diagram.

2. Suppose that the economy is undergoing a recession because of a fall in aggregate demand.

3.
a. Using an aggregate-demand/aggregate-supply diagram, depict the current state of the economy.
b. If real GDP is now 1 percent below last year's value, how does the unemployment rate compare with last .year's rate? (Hint: Review Okun's law.)
c. "Capacity utilization is a measure of how intensive1y the capital stock is being used. In a recession, is capacity utilization above or below its long-run average? Explain.

4. List and explain the three theories for why the short-run aggregate-supply curve is upward sloping.

5. Explain why the long-run aggregate-supply curve is vertical.

6. Assume that the economy begins in long-run equilibrium, and households decide to hold higher money balances than they did before.

a. What happens to the interest rate? Explain.
b. What happens to the quantity of investment demanded? Explain.
c. What happens to the value of the dollar? Explain.
d. What happens to the quantity of net exports demanded? Explain.
e. What happens to aggregate demand? Explain.

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Capacity utilization is emphasized.

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