2. (20 Points) Imagine an economy where general price level is constant, there is no government, and the economy does not trade with foreign economies. Further, assume the following desired consumption and investment functions: C = 300 + 0.9Y , I = 100 4i where, C and I are desired consumption and investment expenditure, respectively and Y shows the national income/output. C, I and Y are all measured in dollars. Finally, i shows the interest rate in percentages. 1

(a) (4 Points) Assume that interest rate is equal to 10% (i = 10). Compute the equilibrium national income under this assumption.

(b) (4 Points) Now, assume that the interest rate is decreased to 5% (i = 5) and remains at this level forever. What will be the new equilibrium national income?

(c) (3 Points) Based on your answers in parts (a) and (b), compute the simple multiplier for this economy. [Hint: use the definition of the multiplier and your answers in previous parts, not a memorized equation.]

(d) (6 Points) Assume that every step of change in output/income takes a year. What will the level of national income be 3 years after the interest rate changes?

(e) (3 Points) If you mistakenly thought that the sequence of changes in national income stops after 3 years, what would you estimate the simple multiplier to be? [Hint: use the definition of the multiplier and changes in national income after 3 years.]