and Policy Analysis Questions (28 points total) Instructions: Write your final numerical answer in the corresponding answer box. 1 . (20 points) Consider an economy described by the following: C = $4.Otrillion I = $1.5trillion G = $3.0trillion T = $3.0trillion NX = $1.0trillion f = 0 mpc = 0.8 d = 0.35 x = 0.15 T = 1% 1 = 0.5 a. Calculate an expression for the IS, MP and AD curves MP curve 1= IS curve Y= AD curve Y= b. Let AS curve be given by the relation: 1 = 6 + 1.5(Y - 25.5) (i.e. the price shock pis zero). What are equilibrium values of inflation, output and the real interest rate {n, Y, r}? 3 8 6 . Y 2.1,5 TT = Y= 1= 5Note: If you use graphs be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; v. the terminal equilibrium values. a. Describe how active (monetary) policy would respond (if at all) to stabilize inflation in response to the shock in part (1.c). What is the likely effect of such policy response (if any) on output stability? (Hint: You can use the AD-AS model and then describe the effect of the shock, the policy response, and its effect on output and inflation with words).b. Describe how would active (monetary) policy would respond (if at all) to stabilize economic activity in response to the shock in part (1.d). What is the likely effect of such policy response (if any) on price stability? (Hint: You can use the AD-AS model and then describe the effect of the shock, the policy response, and its effect on output and inflation with words). in Ac AD3. 5 3 C. Suppose that government purchases are raised from $1.0- trillion to $1 5 trillion. What are new short-run equilibrium values of inflation, output and the real interest rate{n, Y, r}? (Hint: First find the effect of the shock on the IS curve, and then AD curve). IS curve Y= AD curve Y= T = Y= 1= d. Suppose that a financial crisis begins, and f increases tof = 3. (Assume government purchases are again as in part (a)). What are the new short-run equilibrium values of inflation, output, and the interest rate {n, Y, r}? (Hint: First find the effect of the shock on the IS curve, and then AD curve) IS curve Y= AD curve Y= TI = Y=