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QUESTION 2 (25 MARKS)

a. If the government reduces taxes on labor income and interest income, illustrate and explain how potential GDP and economic growth are affected. (10 marks)

b. If actual employment is lesser than full employment, what fiscal policy actions could eliminate the gap? Is there any possible new problem will occur with the policy taken by the government to eliminate the gap? Illustrate and explain what adjustments, if any, take place? (15 marks)