Exercise 1. The [S curve and government stabilizers. Many government transfers automatically increase when the economy goes into a recession. For instance, the unemployment insance program naturally becomes more important when the economy weakens, helping to mitigate the decline in income faced by people when they lose their job. Spending on welfare programslike food stampsand Medicaid also increases automatically during recessions. Because the additional spending provided by these programs occurs automatically and because they ynerally help stabilize the economy, these spending mechanisms are known as automatic stabilizers. Therefore, the automatic stabilizers imply that govemment spending increases when total output decreases (recession), while spending decreases when output increases (booms). If we want to capture this in our model, we would need a specification of government spending G that depends on current output, for example we could assume Implement this specification for government spending into the baseline IS model. The other categarie's of expenditures follow the same rules as in class: It = ElyYr _ HER: _'_')?rv Cl = c: Ext = Earlrt: IMI' = ling} a) Derive the IS curve for this new specification. b) Would the response of output to an increase in the utterest rate be stronger or weaker than in the baseline case? (Notice the negative sign in the specication for G). What is the intuition behind this result? Why is this result different from the case (covered in textbook and class) when consumption equation has a positive cyclical output element in addition to the permanent income component? c) Derive the AD curve for this new specification. Would it be atter or steeper when the cyclical term in the government expenditure is added? Would this be stabilizing or de- stabilizing for the economy