Assume a closed economy without Government. However, there exists a financial sector that creates an array of financial assets on which both households and firms invest. Let denote the average earnings from these financial assets. The consumption expenditure of the households is influenced by their wage income and the financial income and is given by = (, ); > 0, > 0, where , are partial derivatives of consumption with respect to income and financial earnings respectively. Similarly, the real investment expenditure of firms is given by = (, ); > 0, < 0, where , are the partial derivatives of the real investment with respect to income and financial earnings. Note that < 0 implies that the real investment falls as financial earnings for the firm rises. Either using the Keynesian cross model or the Multiplier analysis, answer the following questions.

(i) Identify the wealth effect in this model? [2]

(ii) Derive the relationship between output and financial earnings , and examine the analytical conditions under which the relationship is positive ( >0) and negative ( < 0). [15]

(iii) Describe why the scenario where the expansion in output driven by rise in financial earnings, i.e. when >0, could make the economy unstable and vulnerable to crisis?