Q8. Consider a closed economy that lasts for 2 periods. As in the standard textbook model, the IS curve in the first period is: [IS] : Y = C ( Y - T, Ye - Te, i - me, A) + I(i-me, ye, K)+ G, where T denotes government tax in the first period. Throughout this question, me, Y, and Ge are exogenously fixed. The government budget constraint in the first period is G = T + D, where D is the amount of debt borrowed by government in the first period. Because the second period is the last period, the government can only use taxes T to finance its expenditure G in the second period and to pay back its debt borrowed in the first period. Hence, the government budget constraint in the second period is: Ge + D(1 + i - me) = Te. Suppose that the consumption function C is given by Ye - Te C ( Y - T, Ye - Te, i - ne, A) = a * ( Y - T + 1+ i-me) where a E (0,1) is a parameter. Suppose further that the investment function I is always equal to zero: I (i - me, Ye, K) = 0. a) Use the government budget constraints and the consumption function to show that consumption and output will not be affected by tax cut if the government spending plan, which is characterized by G and G, remains unchanged. (Hint: try to substitute out T and T in the consumption function using G and Ge.) [4 marks] b) What is the fiscal multiplier of government expenditure? In other words, how much would output Y increase if there is a unit increase in G? [2 marks] c) Does Ricardian equivalence hold in this economy according to what you've derived? Explain your answer intuitively. [4 marks]