Consider the impact of an increase in thriftiness in the Keynesian cross. Suppose the consumption function is

C=+c(Y-T)

where is a parameter called autonomous consumption and c is the marginal propensity to consume.

a. What happens to equilibrium income when the society becomes more thrifty, as represented by a decline in ?

b. What happens to equilibrium saving?

c. Why do you suppose this result is called the paradox of thrift?

d. Does this paradox arise in the classical model? Why or why not? (4 Marks)

ii.Use the Keynesian cross to predict the impact on equilibrium GDP of

a. An increase in government purchases.

b. An increase in taxes.

c. Equal-sized increases in both government purchases and taxes. (3 Marks)

iii.The Fed is considering two alternative monetary policies:

holding the money supply constant and letting the interest rate adjust, or

adjusting the money supply to hold the interest rate constant.

In the IS-LM model, which policy will better stabilize output under the following conditions?

a. All shocks to the economy arise from exogenous changes in the demand for goods and services.

b. All shocks to the economy arise from exogenous changes in the demand for money.