1. Suppose the full-employment level of real output (Q) for a hypothetical economy is $250 and the price level (P) initially is 100. Use the short-run aggregate supply schedules below to answer the questions that follow:

1. What will be the level of real output in the short run if the price level unexpectedly rises from 100 to 125 because of an increase in aggregate demand? What if the price level falls unexpectedly from 100 to 75 because of a decrease in aggregate demand? Explain each situation, using numbers from the table.
2. What will be the level of real output in the long run when the price level rises from 100 to 125? When it falls from 100 to 75? Explain each situation.
3. Show the circumstances described in parts a and b on graph paper, and derive the long-run aggregate supply curve.

2. Use graphical analysis to show how each of the following would affect the economy first in the short run and then in the long run. Assume that the United States is initially operating at its full-employment level of output, that prices and wages are eventually flexible both upward and downward, and that there is no counteracting fiscal or monetary policy.

1. Because of a war abroad, the oil supply to the United States is disrupted, sending oil prices rocketing upward.
2. Construction spending on new homes rises dramatically, greatly increasing total U.S. investment spending.
3. Economic recession occurs abroad, significantly reducing foreign purchases of U.S. exports.

3. Suppose the government misjudges the natural rate of unemployment to be much lower than it actually is, and thus undertakes expansionary fiscal and monetary policy to try to achieve the lower rate. Use the concept of the short-run Phillips Curve to explain why these policies might at first succeed. Use the concept of the long-run Phillips Curve to explain the long-run outcome of these policies.

4. What is the Laffer Curve, and how does it relate to supply-side economics? Why is determining the location where the economy is on the curve so important in assessing tax policy?