The IS relation, LM relation, AS relation and AD relations are given by: IS : Y = C(Y ? T) + I(Y, i) + G LM : M P = Y L(i) AS : P = P e (1 + m)F ( 1 ? Y L , z) AD : Y = Y ( M P , G, T) Consider an AS-AD equilibrium at some point A. Assume at this initial equilibrium, P = P e

Question 2) Fiscal Policy in the AS-AD Model (20 points) The IS relation, LM relation, AS relation and AD relations are given by: IS ; Y=C(YT)+I(Y,)+G M LM ; $=YL(i) AS : P=PB(1+m)F(l%,z) M AD ; Y=Y T (PIG?) Consider an AS-AD equilibrium at some point A. Assume at this initial equilibrium, P = P5. (a) [10 points) Suppose the government decides to decrease tax (T). Draw the Short Run Equilibrium effects of this policy using both ISLM and ASAD model. Circle the right changes for each variable listed below when you compare them with the case when there was no policy. Briey explain what happens to the investment in the SR. Clearly label all axis and equilibriums. Write your answers on the next page. 1. 2. 3. 4. Output: Increase / Decrease / Same / Ambiguous Prices: Increase / Decrease / Same / Ambiguous Interest rate: Investment: Increase / Decrease f Same / Ambiguous Increase / Decrease / Same / Ambiguous (b) (5 points) Using the graph of the AS-AD model only, show how we move from the SR-EQ outlined in part (a) to the MR-EQ. Please answer this question on a separate graph using the format below. If you shift either the AS or the AD curve, briefly explain why. (c) (5 points) Is a decrease in tax a neutral policy in the MR? Explain for full credit

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