Unemployment (U-3)= 6.5%

Potential Output (Y*)= $20 trillion

Natural Rate (u*)= 4.5%

(a) Calculate the cyclical rate of unemployment, and explain the type of "gap" you expect to observe here (number and name).

(b) Using Okun's Law, estimate actual GDP (output).

(c) If government spending as a percent of potential GDP had just risen from 18% to 20%, what does the spending allocation model predict would be happening in our economy to consumption, investment, and net exports? Sketch out the spending allocation diagram and show any changes that might have occurred.

(d) Calculate the price of a $10,000 face value bond with three years remaining until maturity with an interest rate set equal to your value of i = u above, and a coupon rate equal to c = u .

(e) Now assume the Fed responds to the situation in (a) by changing interest rates by 1% over the course of the following year. Assume the Fed changes rates in the expected direction based on what you observed in (a). Calculate the new price and rate of return of the same bond with two years remaining. In one sentence, explain the Fed's actions here.