Consider an economy described by the following:

a) (10 points) Derive an expression for the IS curve and MP curve.

b) (5 points) Derive an expression for the aggregate demand curve.

c) (5 points) We consider two inflation rates to 'pin' down our curves. Let point A represent conditions where inflation () = 1% and point B represent conditions where inflation () = 2%. Solve for the equilibrium output and the real rate of interest when =1. Solve for the equilibrium output and the real rate of interest when =2. Label these points as points A (where=1 ) and points B (where= 2) on all three of your diagrams.

Draw three diagrams on your exam sheet with the monetary policy curve and IS curves on top next to each other and the aggregate demand curve below (15 points for correct andcompletely labeled diagrams)

d) (5 points) Suppose that falls to 1.5 trillion.Solve for the equilibrium output and the real rate of interest and label on your diagrams as point C. Assume inflation remains at = 1% ( =1).

C = 5 trillion 1 = 2.5 trillion G = 4 trillion T = 2 trillion NX = -.4 f = 1 mpc = .80 d = 5 X = N 1 = .5 r = 4