1.

Assume that the economy is operating below the full-employment level of output and that the government's budget is balanced. (a) Using a correctly labeled aggregate demand and aggregate supply graph, show how an increase in government spending will affect each of the following in the short run. (i) Real output (ii) Price level (b) Explain how this increase in government spending will affect each of the following in the short run. (i) Real interest rates (ii) Investment Now assume that instead of increasing government spending, the government decreases corporate-profits taxes. (c) Using a correctly labeled aggregate demand and aggregate supply graph, show and explain how this decrease in corporate-profits taxes will affect each of the following. (i) Aggregate demand (ii) Long-run aggregate supply (iii) Real output (iv) Price level (d) Assume that this country produces two goods, X and Y. Draw a correctly labeled production possibilities curve for this economy. Now show on the graph how this decrease in corporate-profits taxes will affect this economy's production possibilities curve.