Problem 1: Carefully explain and show graphically how each of the following changes would effect the shape of the IS curve:
a) The MPC becomes bigger.
b) Investment becomes more sensitive to changes in the real interest rate.
Problem 2: In the State of the union address in January 2002, President Bush announced that he would ask Congress to approve substantial increases in defense spending to counter terrorism and significant reductions in taxes. Show:
a) The short-run effects of his policy on aggregate Expenditure curve and the equilibrium level of GDP.
b) What the effects would be on IS/LM curves.