(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, π = 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 π=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.

(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.