1. Suppose the economy is initially producing at full employment output and the government cuts taxes by $10 billion and increases spending by $25 billion. Calculate the size of the shift in aggregate demand if the MPC = .9, and the resulting change in equilibrium rGDP, and the price level using the AD-AS diagram. Next, illustrate graphically the impact this will have in the money market. What will happen to the interest rate, and the quantity of money demanded?
2. Suppose the Fed sought to neutralize the demand shock in #9. What tools could the Fed use? Explain and illustrate the impact on the money market, and the AD-AS diagram. Determine what happens to the interest rate, investment spending, autonomous consumption, aggregate demand, the price level, and rGDP.