Question 1 Aggregate Demand and Aggregate Supply Suppose that the economy is characterized by the following behavioural equations: Consumption: C = 800 + 0.8 (YT) Real investment: I = 150 + a1}'-1000i Government spending: 6 ==210 Tax revenue: T = 200 + &5Y Central bank policy: i = h + &5(n-HT) Aggregate supply (AS) relation: 1: = 1:8 + 0:50, Y\") The neutral rate of interest is in=0.05, the inflation target of the central bank is n=0.05, the natural level of output is K,= 1900, the labour force is L=2000, and the current expected value of inflation is 7z6=0.lO. a) Derive the IS relation, and draw it in {i, Y} space. Explain its meaning in words. (Hint: solve for an equation with i on the left-hand side - use the parameter numbers given above). (2 marks) b) Substitute the central bank policy relation into the real investment relation, and then derive the AD relation and draw it in {x,Y} space. Explain its meaning in words. (Hint: solve for an equation with on the left-hand side - use the parameter numbers given above). (2 marks) c) Using the AS and AD relations, solve for the current short-run equilibrium inflation rate,.m and output, Y. Are these short-run equilibrium values greater or less than their medium-run values? (3 marks) d) Solve for the short-run equilibrium interest rate, i. (1 mark) e) Calculate the medium-run equilibrium values of real investment, I, and consumption, C. Confirm that Y; = C+I+G in the medium run. (2 marks)