Suppose the economy is initially at a medium-run equilibrium, so that Y = Yn, u = un, r = rn and = e = 0.04.The economy can be described by the following set of equations:

C = 1000 + 0.75(Y - T) I = 400 + 0.15Y - 4500(r + x) G = 800 T = 1000 x = risk premium = 0.06

(a)What is the equation of the IS curve? [Hint: Y is going to be a function of r] [5 Points]

(b) If rn = 0.042, what is the level of potential output? [2 Points]

Suppose there is a large negative shock to consumer and business confidence as a result of the Coronavirus pandemic.The economy can now be described by the following set of equations:

C = 500 + 0.75(Y - T) I = 100 + 0.15Y - 4500(r + x) G = 800 T = 1000 x = risk premium = 0.06

(c)What is the new IS equation? [4 Points]

(d)What is the level of Y now if rn stays at 0.042? [2 Points]

(e)What is the level of output gap (Y - Yn)? [1 Point]

(g)What would r have to be to restore Y back to the level of output you found in Part (b)? [4 Points]