Question: Let: C = consumption, Ip = investment spending (as a function of price level), G = government spending, Tx = tax revenue, Yd = after-tax

Let: C = consumption, Ip = investment spending (as a function of price level), G = government spending, Tx = tax revenue, Yd = after-tax income, Assume for a given closed economy:

C=100 + 0.9 Yd - 20P

Ip= 400 - 40P

G=300

T=100

Moreover, aggregate supply curve for this economy is defined by the following equation:

P=1.41 + 0.0001Y

a. According to the investment equation (Ip= 400 - 40P) as overall price level in the economy increases investment spending decreases. How could you explain this situation? Please use graphs to elaborate your answer.

b. Find the equilibrium level of overall price and aggregate output in this economy. What would be the value of consumption and investment spending at this equilibrium?

c. How would the equilibrium aggregate output and price level change if government spending increases to Gnew=400? What would be the value of consumption and investment spending at this new equilibrium?

d. Compare equilibrium values of investment spending and consumption you find in parts (c) and (d). How would you explain the changes? Elaborate your answer for both investment and consumption.

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