1.Consider an economy described by the following.

G =

Aggregate Demand = AE^planned = C + I ^planned + G + NX

Monetary policy (MP) curve and takes the form:

= 3.25 trillion I = 1.3 trillion = 3.5 trillion

= 3.0 trillion

= -1.0 trillion

= 1%

mpc = 0.75

d= 0.3 (trillion per 1% change)

x= 0.1 (trillion per 1% change)

= 1

r =1%

a.Derive expressions for the MP curve and AD curve.

MP curve:r =____________ + ___________

AD curve: AD = _____________ + ____________ r + ________________ Y

b.Find the income expenditure equilibrium.

IE equilibrium: Y* = ___________ + ____________ r

c.Assume that =1%. What is the real interest rate, equilibrium rate of output, consumption, planned investment, and net exports?

r = __________

Y = __________

C = __________

I ^planned = __________

NX = __________

d.Suppose the Fed increases r to r = 2%. Calculate what happens to the real interest rate, equilibrium level of output, consumption, planned investment and net exports.

r = __________

Y = __________

C = __________

I ^planned = __________

NX = __________

e.Considering that output, consumption, planned investment, and net exports all decreased in part (c), why might the Fed chose to increase r ?

(essay type short answer)

2.Aggregate demand curve of an economy is given by AD = 51 - 0.2P, the long-run aggregate supply, LRAS, is 30 and the short-run aggregate supply is given by SRAS = 0.3 P (all output measures are in US$ billions and the price level is given as an index number).

a.What is the equilibrium price level?

P = __________.

b.What is the actual short-run output?

SRAS = __________ .

c.What is the output gap?

Output gap = __________________.

d.What could be the unemployment rate if the natural rate of unemployment is 5%?

U = ________________ .

e.Assume that the present status of the economy is the result of a supply shock. What could be the original equilibrium (price level and output)?

Original equilibrium price level = _________________ .

Original equilibrium output = _________________.

f.What will be the new long-run equilibrium without any policy action?

Long run equilibrium output = _____________ .

Long run equilibrium price level = ____________ .

g.What will be the aggregate demand curve when the labor market adjusts?

AD = _______ + ________ P