We use the following terminology in this part: aggregate income Y and disposable income Yd (= Y T), consumption function C(Yd), planned investment function I(r), government spending G, and taxation T = tY where t is the marginal tax rate; r% denotes the real interest rate in the economy. (Note, r is in percentage points, e.g. r = 2 means the interest rate is 2%. When doing calculations, the interest rate should not simply be inserted in decimal form. For example, if r = 2 then I(2) = 124 2 = 122.) Consider a hypothetical economy where: C(Yd) = 12 + 0.75 (Y T) I(r) = 124 1 r G = 120 t = 20%

1. Using the information above, write out the planned Aggregate Expenditure equation. (Hint: Remember that this takes the form of AE = . . . .)

2. Write down an expression for the Investment-Savings (IS) Curve. (Hint: First use the AE equation to find an expression for equilibrium Y . Next, remember that the IS equation takes the form of r = ....)

3. Assume that inflation is zero, so that i = r. This economy's central bank follows a given Monetary Policy Rule: r = i = 0.025 Y + 0.0003 P , where P is the price level. Given this and the expression for the IS Curve, write down an expression for the Aggregate Demand Curve. (Hint: Remember that the AD Curve takes the form P = . . . .)

4. Suppose that the price level (P) is 3333.33. What is the equilibrium value of aggregate income, Y ? (Hint: use the AD equation.)

5. What are the equilibrium values of the interest rate, r, and investment, I? (Hint: use the MP R or IS, and I(r) equations.)

6. Suppose that the price level (P) falls to 500. What is the equilibrium value of aggregate income, Y ?

7. What are the new equilibrium values of the interest rate, r, and investment, I?

8. Discuss why the change in the price level has the identified impacts on Y , r and I