1. Suppose that in order to stimulate economy but not to run budget deficit government increases spending as well as income taxes by $400 billion. If marginal propensity to consume is 0.8, what is the overall impact on the national income? Explain quantitatively and present AS/AD graph of the situation.
2. Suppose that money supply is equal to $500 billion and demand for money is given by Md =1000 -100R where R is the interest rate in percentages. If the demand for money increases by 5% what should be the size and direction of an open market operation by the Central Bank to maintain the same interest rate as before? Solve the problem algebraically and present graph associated with your solution.
Problem 6 (20). Suppose that AS/AD model is given by
Yp = $500 billion
P = 200 - 0.1Y
P = 20 + 0.4Y
where Yp is potential GDP, Y is real GDP in billion dollars and P is GDP deflator. By how much overall should government expenditures change to achieve potential GDP level if MPC = 0.8? Calculate the size of inflation/deflation associated with this fiscal policy action. Present graphical interpretation of the problem.