Microeconomic

a) Between 1990 and 1999, the Spanish economy was growing, due in large part to the construction of new housing, which people eagerly purchased. GDP grew every year, inflation fell, and unemployment cycled around the natural rate. How can you use the AS/AD model to explain this? That is, which curves are shifting (if any) and in what direction?

b) Between 1999 and 2007, the housing market in Spain continued to grow rapidly, but many of the houses remained vacant (empty). GDP continued to expand every year, and each year hundreds of thousands of new houses were built, with over half a million new houses built in both 2004 and 2005. During this period, unemployment fell to its lowest rate in over 20 years, but inflation was rising. How can you use the AS/AD model to explain this? That is, which curves are shifting (if any) and in what direction?

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c) During this same period (1999 to 2007), housing prices rose 200%, and the number of vacant houses ballooned. That is, a bubble was being created. In 2008, this bubble burst. As a result, in 2008, housing prices fell 25% on average (up to 42% in some areas) and the building of new houses essentially stopped. The Spanish economy experienced its first contraction of GDP in 15 years, unemployment soared to almost 27%, and inflation turned negative. How can you use the AS/AD model to explain this? That is, which curves are shifting (if any) and in what direction?

d)If the Spanish government had allowed the economy to self-correct, what would have happened? That is, which curves would have shifted (if any) and in what direction? What would have happened to price level, GDP, and unemployment?

e) Instead, the Spanish government intervened with a financial bailout. Using the AS/AD model (be clear about which curves are shifting, if any), explain what changes this would result in. That is, what would happen to GDP, unemployment, and inflation? What would happen to interest rates?

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