2. Barovia is an economy with fixed prices whose firms are willing to increase or decrease output in the short run to meet consumer demands. Its aggregate expenditure varies with interest according to the Interest Sensitivity (IS) equation Y = 500 - 20 Where Y is output measured in dollars and r is the real interest rate, measured in percentage points (so that r = 10 means "10%"). The Count of Barovia determines the risk-free rate of the economy. The risk-free rate is initially set to 3%. a. Barovia is quite a risky place to invest. Its risk premium is 10%. What is the real interest rate in Barovia? What is the short run level of output Y? b. Outside agitators create political instability, which increases the liquidity risk of the system. The risk premium rises to 13%. i. How much does Y change because of this rise in risk? ii. If the Count wants to maintain Y at its original level, what should he do with the risk-free rate? iii. Draw a graph illustrating the shift due to increased risk, and the correction by the monetary authority. a c. Return to the original setup, with a risk-free rate of 3% and a risk premium of 10%. The outsiders bring new spending to the economy, and boost consumer confidence by promising systemic reform. The IS curve shifts to become Y = 550 - 20r, all else equal. i. If monetary policy does not change, how do output and real interest rates change? ii. If the Count adjusts interest rates to keep Y fixed at its initial level, how do output and real interest rates change? iii. Draw a graph illustrating each of these possibilities