(A)Consider Utopia's economy with a desired linear consumption function with the peculiarity

that they do not like the dictatorial government spending. Thus their consumption declines when

their government starts spending more. ( G=Govt expenditure, Y=Disposable Income, i=nominal

interest rate, r=real interest rate, P=Price level, = expected inflation rate).

Consumption function as

C(d) = 100 + 0.8Y -500r-0.5G

and desired investment function as

I(d) = 100 -500r

Their real money demand is

M(d)/P = Y- 2000i

Other variables are =0.05, G = 200, Y = 1000 and M= 2100

(a)Find the equilibrium values of the real interest rate, consumption, investment, and the price

level.

[Hint; Use Fisher equation and Components of AD] (5)

(B) In the classical model, analyse the effects of an increase in the government spending,

financed by selling bonds to the public, on output, employment and the price level. (5)