1. Suppose a government moves to reduce a budget deficit. Using the long-run model of the economy graphically illustrate the impact of reducing a government's budget deficit by reducing government purchases. Be sure to label the axes, the curves, the initial equilibrium values, the direction curves shift, and the terminal equilibrium values.

2. State in words what happens to (i) the real interest rate; (ii) national saving; (iii) investment; (iv) consumption; and (v) output.

Answer Key 1. a. S1 S2 $1 = 1 52= 12 S, I b. i. The real interest rate decreases. ii. National saving increases. iii. Investment increases. iv. Consumption is unchanged. v. Output is unchanged; it is fixed because it is determined by the factors of production