Cbar is a "C" with a line on top like this C. Ibar is an "I" with a line on top like this I.

So C = Cbar + mpc(Y-T) - ar and IP= Ibar - br.

Don't worry about % for r. When r = 1.6, just use 1.6.

Let's use the Keynesian framework to think about the recent recession. For all time periods, let mpc = 0.6, a = 1000, and b = 1000. For February 2020, let Cbar = $4,600,G = $3,500,Ibar = $5,600,NX = - $500, T = $2,000, and r = 1.6. In March 2020, the hospitals are overwhelmed with Covid patients. People are afraid to leave their homes, so Cbar drops to $700. Firms expect fewer customers and a recession of unknown duration, so Ibar drops to $3,100. NX also decreases, to -$1,000. To fight the coming recession, the government increases G to $5,000 and decreases T to $0, and the Fed lowers r to 0.1.

Part 1

What is Output in February 2020?

What is Output in March 2020?

Suppose Output in February 2020 is the Potential Output. What is the Output Gap in March 2020?

Further suppose unemployment in February 2020 is 5%. What is unemployment in March 2020?

Part 2

The government could adjust spending on goods and services or adjust taxes and transfers to bring the economy back to potential output.

How much would the government need to spend on goods and services to bring the economy back to potential output in March 2020?

How much would the government need to collect in taxes to bring the economy back to potential output in March 2020?

Suppose the government is required to have a balanced budget. What would government spending on goods and services and taxes be to bring the economy back to potential output in March 2020? (one point each)

Part 3

Suppose the Fed did nothing and left r = 1.6 What would the Output be in March 2020?

Suppose the Fed lower r so that Output in March 2020 equals Potential Output. What would r be?

Low interest rates make saving less attractive and make borrowing more attractive. Households could borrow and spend on goods and services or buy assets. Give an example of borrowing to buy an asset that increased during the pandemic but typically does not contribute to GDP.