The closed economy of Temptation Island is characterized by the following equations: Consumption: C = 6000 + 0.85(Y - T) Investment: I = 1500 - 300r Government spending: G = 5000 Taxes: T = 4500 Real money demand: L = 0.65Y - 500i Expected inflation: 0 Production function: Y = K1/2 L1/2 The nominal money supply = 35000

Note: Interest rates, both i and r, are expressed in percentage points, i.e., if r = 5.5, then the real interest rate is interpreted as being equal to 5.5%.

Suppose the IS-LM model can be to describe Temptation Island and answer the following questions. Keep your answer to at least THREE decimal points if necessary. a) Derive the IS and LM equations for this economy. (4 points)

b) Suppose we are in the base period, so the price level is fixed at 1.00. Calculate the resulting short-run equilibrium values of real output, real interest rate, investment, consumption, the government budget balance, and price level. (3 points)

c) Suppose, in the long-run, 64000 (real) units of capital are utilized and 36000 workers are employed. Calculate the resulting full-employment values of real output, real interest rate, investment, consumption, the government budget balance, and the price level. (3 points)

d) Suppose the government decides to change the level of taxation to create a budget surplus of 600. Calculate the resulting (new) short-run equilibrium values of real output, real interest rate, investment, and consumption. Determine the unemployment rate that results in short- run equilibrium. (6 points)