1. The following equations describe a small, closed economy. Figures are in millions of dollars;interestrate(i)is in percentperannum. Assumethat thepricelevelis fixed.

GoodsMarket MoneyMarket

C= Co+ cYD (Privateconsumption) (M/P)^d= kY- hi(Demand forrealbalances)

YD=Y+ TR -T (Disposableincome) (M/P)^s=M0/P (Real moneysupply)

T =To+tY (Totaltaxes) (M/P)^d=(M/P^s(Money mkt. eq. condition)

I= Io - bi (Privateinvestment)

G=Go, TR=TRo (Govt.Expenditure&Transfers)

Y=C +I +G (Goodsmkt.eq.condition)

Endogenous Variables:C,YD, T, I,Y,i,M^d andM^s

Exogenous Variables:Co=250, To=150,Io = 300,Go =350,TRo = 100,

Mo=500and P=1

Parameters: c =0.80, t=0.25, b =50, k =0.25 and h=62.5

Policyvariables: Fiscal policy:(G,t andTR),Monetarypolicy:(Mo,P)

1. Derivethe equationsforISandthe LMcurves.(4marks)

1. Determinethe equilibriumlevelofincome(Y*)andtherateofinterest(i*).(2 marks)

1. Suppose government increases its expenditure (G) by 20 percent of the current levels.Calculate the change in the level of income (Y) and the rate of interest (i) that resultsfromthis fiscal expansion.(2 marks)

1. Determine the magnitude of crowding-out of private sector investment that result fromtheabovefiscal expansion.(2 marks)