1. Explain how your answers to Test Yourself Question 5 would differ if each of the assumptions changed. Specifically, what sorts of changes in the assumptions would weaken the effects of monetary policy?
2. (More difficult) Consider an economy in which government purchases, taxes, and net exports are all zero. The consumption function is
C = 300 + 0.75Y and investment spending (I) depends on the rate of interest (r) in the following way:
I = 1,000 - 100r
Find the equilibrium GDP if the Fed makes the rate of interest
(a) 2 percent (r = 0.02),
(b) 5 percent, and
(c) 10 percent.