An economy is described by the following equations:

C = 1,600 + 0.6(Y − T) − 2,000r

I^P = 2,500 − 1,000r

G = 2,000

NX = 50

T = 2,000

The Bank of Lotusland, the central bank, has announced that it will set the real interest rate according to the policy reaction function found in the table below:

Inflation rate, π	Real interest rate, r
0.00	0.02
0.01	0.03
0.02	0.04
0.03	0.05
0.04	0.06

a. Find an equation relating planned aggregate expenditure to output and the real interest rate.

PAE = + Y − r

b. For each of the rates of inflation given below, find autonomous expenditure and short-run equilibrium output in Lotusland.

Inflation rate, π	Real interest rate, r	Autonomous expenditure	Equilibrium output
0.00	0.02
0.01	0.03
0.02	0.04
0.03	0.05
0.04	0.06

Using the data above, graph the AD curve.

Instructions: In the graph below, use the line tool 'AD' to draw the aggregate demand line for levels of inflation 4 percent and 0 percent. Draw only the two endpoints.

c. Repeat parts a and b, assuming that government purchases have increased to 2,100. How does an increase in government purchases affect the AD curve?

New PAE = + Y − r

For the rates of inflation given, find autonomous expenditure and short-run equilibrium output in Lotusland after the increase in government purchases.

Inflation rate, π	Real interest rate, r	Autonomous expenditure	Equilibrium output
0.00	0.02
0.01	0.03
0.02	0.04
0.03	0.05
0.04	0.06

Using the data above, graph the new AD curve.

Instructions: In the graph below, use the line tool 'AD' to draw the aggregate demand line for levels of inflation 4 percent and 0 percent. Draw only the two endpoints.

The increase in government purchases shifts the AD curve (Click to select) left downward right by units at each inflation rate.

Answer rating: 100% (QA)

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