Q3: Consider a simple economy with only two sectors (consumption and government).

a/ Show how a balanced budget can result. Explain your diagrams and answer in words. (5 marks)

b/ If expected inflation is 3.5% per annum and a typical burger costs $10 today, how much will a typical burger cost in 5 years from now in nominal terms? Explain your working and answer in words. (5 marks)

c/ If technology causes a significant reduction in the cost of typical bread, explain why the typical burger's cost in 5 years could still be the same as it is now? Explain your working and answer in words. (5 marks)

d/ The central bank and government of this economy wishes to reduce inflation but also stimulate investment. Should it use domestic or foreign bonds to achieve this? Draw diagrams and explain your answer. (10 marks)