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100% + 1. (50 points) Consider a one-period closed economy, i.e. agents (consumers, firms and government) live for one period, consumers supply labor and demand consumption good, whereas firms supply consumption good and demand labor, and government fi- nances an exogenous spending via lump-sum taxes. Suppose that individuals preference change and they favor leisure more than consumption, i.e marginal rate of substitution of leisure for consumption increases (indifference curves become steeper). (a) (20) Analyze the effects of the change in preferences on the consumption/leisure choice of the individuals given a constant wage and tax. Support your answer with appropriate graphs. (b) (25) What will be the effects of the change in preferences on equilibrium quan- tities and prices (specifically consumption, hours worked, output and real wage). Explain your answer with supporting graphs. (c) (5) Based on your answer to part (b) and (c), do you think that such a change in preferences might explain business cycles? Explain why or why not, with reference to the key business cycle facts. 2. (50 points) Consider the same economy as in Question 1. (a) (25) Analyze the effects of a increase in government spending. What happens to consumption, output, employment, wage and consumer's welfare? (b) (25) Now, suppose that the government uses the increase in government spending to build highways and improve the infrastructure in the economy which makes firms more productive. That is, you can think of such a government spending as a increase in the productivity of firms in our simple model. What are the net effects of such an increase in government spending on consumption, employment, output, wages and welfare? 9 R