Consider a hypothetical economy where:

C(Yd) = 105 + 0.8 x (Y T)

I(r) = 74 1 x r

G = 65

T = 50

1. Using the information above, write out the planned Aggregate Expenditure equation. (Hint: Remember that this takes the form of AE = . . . .)

2. Write down an expression for the Investment-Savings (IS) Curve. (Hint: First use the AE equation to find an expression for equilibrium Y . Next, remember that the IS equation takes the form of r = ....)

3. Assume that inflation is zero, so that i = r. This economy's central bank follows a given Monetary Policy Rule: r = i = 0.003 x Y + 0.001 x P where P is the price level. Given this and the expression for the IS Curve, write down an expression for the Aggregate Demand Curve. (Hint: Remember that the AD Curve takes the form P = . . . .)

4. Suppose that the price level (P) is 1000. What is the equilibrium value of aggregate income, Y ? (Hint: use the AD equation.)

5. What are the equilibrium values of the interest rate, r, and investment, I? (Hint: use the MPR or IS, and I(r) equations.)

6. Suppose that the price level (P) falls to 500. What is the equilibrium value of aggregate income, Y ?

7. What are the new equilibrium values of the interest rate, r, and investment, I?

8. Discuss why the change in the price level has the identified impacts on Y , r and I.