Practice questions:

(25pts) 2. Suppose the government wants to reduce its budget deficit. Using the long-run model of the economy developed in Chapter 3, illustrate graphicallythe impact of the alternative fiscal policy measures indicated in parts (a) and (b) below. Be sure to label: (i) the axes; (ii) the curves; (iii) the initial equilibrium values; (iv) the direction curves shift; and (v) the final equilibrium values.

(15) a)Suppose the government decides to reduce the government's budget deficit byreducing government expenditures.What happens to: (i) national saving; (ii) the real interest rate; (iii) investment; (iv) consumption; and (v) output? Illustrate graphically and explain in words why these variables change or why they do not change.

(10) b)Suppose the government decides toreduce both government expenditures and taxes by the same amount(this is a "balanced budget" change). What happens to: (i) national saving; (ii) the real interest rate; (iii) investment; (iv) consumption; and (v) output?Illustrate graphically and explain in wordswhy these variables change or why they do not change.