Suppose that the economy of Guerre can be described by the following

equations:

C = 4000 + 0.75Y_D

I = 1000

G = 4000

T = 0.2Y

X = 500

IM = 0.1Y

a. [2 points] Derive the equation for aggregate expenditure function as a function of income.

b. [2 points] Calculate equilibrium output.

c. [2 points] Show both AE and equilibrium output graphically.

d. [2 points] Calculate the spending multiplier.

e. [2 points] Calculate Guerre's budget balance. Does it have a budget surplus or a

budget deficit?

f. [2 points] Calculate Guerre's net exports. Does it have a trade surplus or a trade

deficit?

g. [4 points] The Grand Leader of Guerre increases government spending by 500, so that G = 4500, in order to pay for military supplies. What will be the new level of equilibrium output? Show graphically the change in equilibrium GDP.

h. [4 points] The Grand Leader has heard of a report by some economists on the impact of a war on consumer confidence. It speculates that anxiety about the future will cause aggregate consumer demand to fall, and that a large government deficit now will cause consumers to worry about the likelihood of higher taxes in the future to pay for the debt that is being accumulated. The two influences together imply that the amount of aggregate consumption may be given by the new consumption function: C = 4000 + 0.7Y_D. Now what will short-run equilibrium national output be, if government spending changes (as in part (g)), but consumer behaviour also changes (as in the new consumption function)? Discuss your results. Show graphically how the change in consumer behaviour affects the equilibrium level of GDP.