3- Assume to start out with that the economy of Freedonia is at potential output. The inflation rate is 2%, the natural rate of unemployment is 5%. Assume that the marginal product of capital is 3% and that b=2 and v=1/2. You will need graphs and equations to answer these questions.

a- Now assume the country of Sylvania declares war on Freedonia. In response, Freedonia increases government spending by 10 percentage points above its long run share of output. What will this do to the economy?

b-. What will this do to unemployment, the inflation rate and the change in inflation?

c-. If the Central Bank of Freedonia (CBF) does not change the nominal interest rate what will happen to the real interest rate after war preparations start?

d. Will the CBF want to raise the real rate? Why or why not? If it does, what does it need to increase the real rate to bring the economy back to potential? What will the nominal rate have to be?