1. [5 points] What is stagflation?

2. [15 points] Assume that GDP is $6,000, personal disposable income is $5,100, and the government budget deficit is $200. Consumption is $3,800, and the trade deficit is $100.

a) [5 points] How large is saving (S)?

b) [5 points] how large is investment (I)?

c) [5 points] How large is government spending (G)?

3. [25 points] Look at the role taxes play in determining equilibrium income. Suppose we have an economy described by the following functions: = 50 + 0.8 = 70 = 200 = 100 = 0.20

a) [5 points] Calculate the equilibrium level of income and the multiplier in this model.

b) [5 points] Calculate the budget surplus, .

c) [5 points] Suppose that increases to 0.25. What is the new equilibrium income? the new multiplier?

d) [5 points] Calculate the change in the budget surplus. Would you expect the change in the surplus to be more or less if = 0.9 rather than 0.8?

e) [5 points] Can you explain why the multiplier is 1 when = 1?

4. [10 points] Using the IS-LM model, graph and explain how the monetary authorities could avoid a crowding out effect caused by fiscal expansion.

5. [15 points] Using the AS-AD model (graph and explanation), suppose that the government increases spending from G to G while simultaneously raising taxes in such a way that, at the initial level of output, the budget remains balanced.

a) [5 points] Show the effect of this change on the aggregate demand schedule.

b) [5 points] How does this affect output and the price level in the Keynesian case?

c) [5points] How does this affect output and the price level in the classical case?

6. [10 points] Suppose short-run output exceeds full potential output by 3 percent.

a) [5 points] According to Okun's law, what is the effect on unemployment?

b) [5 points] Assuming that inflationary expectations are constant, what is the effect on wages