Q1)

Consider Utopia's economy with a desired linear consumption function with the peculiarity

that they do not like the dictatorial government spending. Thus their consumption declines when theirgovernment starts spending more.

(G=Govt expenditure, Y=Disposable Income, i=nominal iinterestrate, r=real interest rate, P=Price level, = expected inflation rate).

Consumption function as C(d) = 100 + 0.8Y -500r-0.5G

and desired investment function as I(d) = 100 -500r

Their real money demand is M(d)/P = Y- 2000i

Other variables are =0.05, G = 200, Y = 1000 and M= 2100

(A)Find the equilibrium values of the real interest rate, consumption, investment, and the price

level. [Hint; Use Fisher equation and Components of AD] (5 marks)

(B) In the classical model, analyse the effects of an increase in the government spending,

financed by selling bonds to the public, on output, employment and the price level. (5 marks)

02)

(A)What is nominal interest rate ? If inflation rises from 4 to 7 per cent or the real interest rate

changes from 6 to 8 percent, then what will happen to the nominal interest rate according to

Fisher Effect ? Whatis the social cost of expected inflation? (1,2,3 marks)