1. Use the IS-LM model to determine the effects of a decrease in government spending on the general equilibrium values of the employment, output, the real interest rate, consumption, investment, and the price level. Illustrate your answer with the appropriate IS-LM-AD-SRAS-LRAS graph. Make sure to label the axes, and curves. Show movement and shifts.

a. What is the short-run impact on prices, real interest rates and output? Explain the shifts and movements. What happens to employment, consumption, investment? Why?

b. If the central bank does not take any policy actions, what will be the long-run impact of the decrease in government spending on prices and output? Show the changes on the graph above, clearly distinguishing between short run and long run. Explain the shifts and movements. What happens to employment, output, the real interest rate, consumption, investment, and the price level in the long run? Why?

c. What can the central bank do to keep output constant? Redraw the AD-SRAS-LRAS and the IS-LM graphs and show the changes. Explain the shifts and movements. What happens to employment, output, the real interest rate, consumption, investment and prices? Why?