1. Assume the country of Strongland is operating at full employment with a balanced budget.

(a) Draw a correctly labeled Phillips curve that illustrates the country’s current economic situation and label it A.

(b) The government engages in a war that it decides to finance by borrowing. What effect will this have on each of the following? (i) The government’s budget balance (ii) The real interest rate

(c) Given your answer in part

(b) (ii), what will be the impact on each of the following? (i) Private interest-sensitive spending. Explain. (ii) Long-run economic growth. Explain.

(d) On your graph in part (a), show the effect of military spending and label it point B.

(e) Identify the open market operation that the central bank should use to bring the country back to full employment.

(f) What is the effect of the monetary policy identified in

(e) on the price level? (g) Now assume that the price of oil increases. What is the effect of each of the following? (i) Price level (ii) Short-run Phillips curve