Imagine that the economy is at a point on that is below both AA and DD,where both the output and asset markets are out of equilibrium.Which first action is TRUE?
A)The economy will stay at this level in the short run.
B)The exchange rate will first rise to a point on the AA schedule.
C)The exchange rate will first rise to a point on the DD schedule.
D)The AA-DD equilibrium will shift to the position of the economy.
E)The output level will first increase to a position on the DD schedule.

Question

Quizplus · Accepted Answer

This situation suggests that the economy is currently producing less than its potential output and that asset prices are currently undervalued. To restore equilibrium, a higher level of output and higher asset prices are needed. Therefore, the exchange rate needs to increase to a point on the AA schedule, which will cause output to increase to the level shown on the AA schedule and asset prices to increase to the level shown on the DD schedule. The economy will eventually reach the AA-DD equilibrium. However, it may take time for the market to adjust to the new equilibrium position.

Imagine That the Economy Is at a Point on That