1. Consider an economy described by the following
𝐶̅ = $3.25 𝑡𝑟𝑖𝑙𝑙𝑖𝑜𝑛
𝐼̅ = $1.3 𝑡𝑟𝑖𝑙𝑙𝑖𝑜𝑛
𝐺̅ = $3.5 𝑡𝑟𝑖𝑙𝑙𝑖𝑜𝑛
𝑇̅ = $3.0 𝑡𝑟𝑖𝑙𝑙𝑖𝑜𝑛
̅𝑁𝑋̅̅̅ = −$1.0 𝑡𝑟𝑖𝑙𝑙𝑖𝑜𝑛
𝑓̅ = 1 𝑚𝑝𝑐 = 0.75 𝑑 = 0.3 𝑥 = 0.1 𝜆 = 1 𝑟̅ = 1
a. Derive expressions for the MP curve and the AD curve
b. Assume that π=1. Calculate the real interest rate, the equilibrium level of output, consumption, planned investment, and net exports.
c. Assume that π increases to π=2. What are the real interest rate and the equilibrium level of output?
d. Suppose the Fed increases 𝑟̅ to 𝑟̅ = 2. Calculate the real interest rate, the equilibrium level of output, consumption, planned investment, and net exports. Why might the Fed choose to increase
e. Suppose the government spending increases to $4 trillion. What happens to the equilibrium output? If the Fed wants to keep output constant, what monetary policy change should it make?
2. For each of the following situations, show how (if at all) the IS, MP, and AD curves are affected. Show clearly any shifts or movements along the curves. If there is no change, just type “No change in …”
a. A decrease in financial frictions
b. An increase in the current inflation
c. Firms become more optimistic about the future of the economy
d. An autonomous monetary policy tightening occurs
e. An increase in taxes and an autonomous easing of monetary policy happens at the same time
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