Assume C = c0 + c1YD I = b0 + b1Y − b2i and furthermore exogenous G and T, and c1 + b1 < 1.

(a) Solve for equilibrium output. State the multiplier, and compare it to that of Questions 1 and 4(a). 2

(b) Assume the central bank sets the interest rate at i = i ∗ , and that the IS curve intersects the LM curve at Y = Y ∗ . Draw an IS-LM diagram to illustrate.

(c) The equilibrium condition in the financial market is M/P = d1Y − d2i. Suppose the federal government implements a fiscal expansion through an increase in G, while the central bank maintains i = i ∗ . What are the consequences of these policies in goods and financial markets, respectively? Briefly explain.