In the standard Keynesian Cross model we assumed that investment did not depend on income. To make the model somewhat more realistic, let's consider the possibility that investment depends positively on Y. That is, when the economy is doing well, firms are more likely to spend more money on building equipment and factories. This is summarized by the following set of equations.

C = C0+C1(Y-T)

G=G

I=I+aY

NX=NX

Assume that C1+a<1and a>0.

a.Solve this model for the equilibrium level of output, .

b.What is the fiscal multiplier in this economy? How does it compare to the regular multiplier of1/(1-c1)?

In addition to the assumptions above, assume that net exports also depend on income (when incomes are higher, people demand more imports). Specifically, suppose that NX=NX-bY, where b>0.

c.Solve for the equilibrium level of output with this new assumption.

d.How does the fiscal multiplier compare to the regular multiplier of1/(1-c1)and to the multiplier you derived in part (b)?