General Equilibrium and Market Clearing $(27$ pts$)$

Utilizing the full ISLMFE model in class, for the following situations draw two gures. For the rst gure draw the

initial shock to the economy and how it impacts the IS$,$ LM or FE curves. Explain why the curves shift. You do not

have to worry about all three markets clearing at the same interest rate for now. $($i$.$e$.$ the money market can stay

at a dierent equilibrium interest rate than the goods market and you don't have to tell me how prices adjust$)$ For

the second gure, draw how the economy moves back into equilibrium in the exible price scenario $($Next Problem

Set I'll ask about the sticky price scenario$).$ Once again explain why and how the curve or curves shift to reach

equilibrium. What happens to the level of full employment output, household consumption and the real interest

rate in this scenario

$($a$)(6$ pts$)$ The Federal Reserve engages in contractionary monetary policy

$($b$)(7$ pts$)$ Government decreases spending today with a concurrent decrease in lump sum taxation

$($c$)(7$ pts$)$ A friend drops o a bunch of capital on your shores, this is an increase in capital stock today

$($d$)(7$ pts$)$ Government decreases spending today but only decreases taxes in the future. In this case Ricardian

equivalence doesn't hold such that the decrease of future taxes in present value terms is less than the decrease

in government spending today $(|$G$1|<|$T$2|).$ Compare the magnitude of your respone to part $($b$)$