The following equations describe an economy. (Think ofC, I, G,etc., as being measured in billions andIas a percentage; a 5 percent interest rate impliesI=5).

C = 0.8 (1 - t) Y

t = 0.30

I = 1000 - 50i

G bar = 500

L = 0.25Y - 65i

M bar / P bar = 700

1.) Derive theISequation.

2.) Derive theLMequation.

3.) What are the equilibrium levels of income and interest rate?

4.) What is the value ofa_Gwhich corresponds to simple multiplier with taxes?

5.) What would be the new equilibrium levels of income and interest rate if the congress passed a tax-cut and the new tax rate was 25%, and concurrently, people became less frugal and consequently marginal propensity to consume increases to 0.90.

6.) If the increased spending overshoots and the economy starts to experience inflation, calculate the new levels of equilibrium income and interest rate if the new Federal Reserve decided to curb spending and by lowering the real money supply to 550?

7.) For each step, graph theISandLMcurves and clearly show their movements for the problems above. Although the graph needs not to be precise, you must clearly show ifISorLMcurves shifted or tilted and in which direction.