Part 2. Short Answers, Graphing

1. Explain the effects of the government running a budget surplus. Organize your answer by:

(a) Explaining what happens in the market of loanable funds. What happens with investment, saving, the real interest rate? Illustrate your answer with a graph of the loanable funds market.

(b) Explaining what happens in the long-run with the natural level of output Y . Illustrate your answer with a graph of the LRAS.

2. In macroeconomics, what things might be true in the short run but not in the long run? Give at least two examples.

3. Explain and illustrate the effect on aggregate demand of

(a) a tax cut of 4T only to the richer group of the population.

(b) a tax cut of 4T only to the poorer group of the population.

4. During an economic expansion the government decides to reduce its budget deficit by increasing income taxes and decreasing government purchases.

(a) What is the effect on consumption? Investment? Prices? Aggregate Demand? Short-Run Aggregate Supply?

(b) Show graphically the effects of this type of policy with the AD-AS model and the market of loanable funds. (Hint: Use the market of loanable funds to show the effect in investment).