Consider a closed economy whose aggregate demand is described by the NIPA equation: Y = C+I+G where the individual components of the NIPA equation are given by C=+mpc x (Y - T) I=-v x (r + ) G= G Note that in this economy, consumption and investment spending respond to the nominal interest rate (i~r + ). In this economy, short-run aggregate supply is given by = y x (r - Yn) +p Long-run aggregate supply is fixed at Y = YN a)Plot the short-run aggregate supply, long-run aggregate supply, and aggregate demand curves and show the dynamics of (i) a negative permanent supply shock; (i) a negative temporary supply shock and a positive demand shock that occur simultaneously, in two separate graphs. (this requires no math and does not involve the equations above). What happens to inflation in each case? b)Derive the aggregate demand equation using the NIPA equation as well as the consumption function, government spending function and the level of investment spending. c)Suppose the following values: = 12, = 5, T= 5, G= 5, mpc = 0.6, v = By how much does the aggregate demand curve shift to the left if C decreases to 10? d)Now suppose that consumption decisions depend on the rate of inflation. Consumers do not like to consume whn prices go up, meaning that the consumption function is given by C = + mpc x (Y -T) - h . This yields the following system of equations that determine aggregate demand: C = +mpcx (Y - T) - h T=I-v x (r+ ) G = G Do the following: i) Derive the new aggregate demand equation; i) starting from 7 = 0, show graphically what would happen if 7 increases, inflation goes up. E) Suppose that increases from 0.02 to 0.08. How much must the Federal Reserve change interest rates to return investment to its previous value? What happens to output at this level