1- B. constant returns to scale.

2- A. 20 percent
3- A. is smaller than depreciation.
4- B. 20
5- C. highest level of consumption.
6- B. It will fall instantly and then will rise gradually.
7- D. n + g.
8- A. rate of technological progress.
9- D. 40
10- A. shift to the right
11- B. shift to the left.
12- D. the price level.
13- C) equality of planned expenditure and income in the short run.
14- D) decreases; downward
15- C) interest rates and income that bring equilibrium in the market for goods and
services.
16- D) 260.
17- C) increase as real income increases.
18- B) LM; right
19- A) price level; increase
20- B) increase

Part II

a) To find the equilibrium level of income (Y) when the interest rate (r) is 6, we need to
set up the equation for aggregate demand (AD), which is the sum of consumption (C),
planned investment (I), and government spending (G). In equilibrium, aggregate
demand equals aggregate supply (Y).

AD = C + I + G

Given the consumption function C = 700 + 1/2(Y - T), planned investment I = 500 - 50r, G =
500, and T = 400, we can plug in these values and the interest rate r = 6:

AD = (700 + 1/2(Y - 400)) + (500 - 50 * 6) + 500

Now, we solve for Y:

Y = (700 + 1/2(Y - 400)) + (500 - 300) + 500 Y = (700 + 1/2(Y - 400)) + 200 + 500 Y = 700 + 0.5Y
- 200 + 200 + 500 Y = 0.5Y + 1200
To find Y, we need to isolate it:

0.5Y = 1200 Y = 1200 * 2 Y = 2400

The equilibrium level of Y when r = 6 is 2400.

To verify if S = I in equilibrium, we first need to find savings (S). Savings can be calculated
using the equation S = Y - C - T. Plugging in the values we have:

S = 2400 - (700 + 1/2(2400 - 400)) - 400 S = 2400 - (700 + 1/2 * 2000) - 400 S = 2400 - (700 +
1000) - 400 S = 2400 - 1700 S = 700

Now we calculate planned investment (I) when r = 6:

I = 500 - 50 * 6 I = 500 - 300 I = 200

In this case, S does not equal I, as S = 700 and I = 200.

b) Given the increase in government spending (G) by 100, the new value of G is
600. The consumption function, planned investment, taxes, and interest rate
remain the same.

To find the new equilibrium level of income (Y), we set up the equation for aggregate
demand (AD), which is the sum of consumption (C), planned investment (I), and the
new government spending (G'). In equilibrium, aggregate demand equals aggregate
supply (Y).

AD = C + I + G'

Given the consumption function C = 700 + 1/2(Y - T), planned investment I = 500 -
50r, G' = 600, T = 400, and r = 6, we can plug in these values:

AD = (700 + 1/2(Y - 400)) + (500 - 50 * 6) + 600

Now, we solve for Y:

Y = (700 + 1/2(Y - 400)) + (500 - 300) + 600 Y = (700 + 1/2(Y - 400)) + 200 + 600 Y =
700 + 0.5Y - 200 + 200 + 600 Y = 0.5Y + 1300

To find Y, we need to isolate it:

0.5Y = 1300 Y = 1300 * 2 Y = 2600

The new equilibrium level of Y when G increases by 100 and r = 6 is 2600

In an IS-LM setting where r is not held fixed, would the increase in G increase or
decrease r? What effect would the change in r have on investment? What is the name of
this phenomenon?

In an IS-LM setting where the interest rate (r) is not held fixed, an increase in
government spending (G) would shift the IS curve to the right. This shift represents an
increase in aggregate demand due to higher government spending. In response to
the shift in the IS curve, the equilibrium point between the IS and LM curves would
move to a higher level of income (Y) and a higher interest rate (r).

The increase in the interest rate (r) would have a negative effect on investment. As
interest rates rise, the cost of borrowing for businesses and consumers increases,
which leads to a reduction in investment activities.

This phenomenon is known as "crowding out." When government spending increases

and raises interest rates, private investment is crowded out or reduced because of the
higher borrowing costs. This effect can partially or entirely offset the stimulative
impact of increased government spending on the economy.

PART3

a) When the Central Bank increases the money supply, it results in lower interest rates.
Lower interest rates make borrowing cheaper for businesses and consumers, which in
turn leads to higher investment and consumption. This increase in investment and
consumption raises the aggregate demand in the economy.

In the context of the IS-LM model, an increase in the money supply shifts the LM curve to
the right. This shift represents an increase in the real money supply at each interest rate
level. As a result, the equilibrium point between the IS and LM curves moves to a higher
level of income (Y) and a lower interest rate (r).

When graphing this change, you would see the LM curve shift to the right, and the new
equilibrium point would lie at a higher level of income (Y) and a lower interest rate (r)
compared to the initial equilibrium point. The aggregate demand curve, in turn, would shift
to the right, indicating higher demand at each price level.

To summarize, an increase in the money supply by the Central Bank leads to a rightward
shift in the aggregate demand curve, representing higher demand at each price level due to
lower interest rates, increased investment, and higher consumption.

b) In the short run, an increase in the money supply can lead to an increase in the level of
output and an increase in the price level. This is due to the fact that when the Central
 Bank increases the money supply, there is more money available for spending, which
can stimulate demand for goods and services, and thus increase the level of output.

However, this increase in demand may also lead to an increase in the price level, as
businesses may raise prices to take advantage of the increased demand.

In the long run, the impact of an increase in the money supply on output and prices may be
less clear. If the increase in the money supply leads to an increase in investment, innovation,
and productivity, then the level of output may increase in the long run. However, if the
increase in the money supply leads to inflationary expectations, then businesses and
consumers may adjust their behavior and prices may rise even more, leading to an increase
in the price level in the long run.

Overall, the impact of an increase in the money supply on output and prices depends on a
variety of factors, including the initial state of the economy, the nature of the increase in the
money supply, and how businesses and consumers respond to the change in monetary
policy.

c) Okun's law states that there is a negative relationship between the

unemployment rate and the output gap, which is the difference between actual
output and potential output. Specifically, Okun's law suggests that a 1% increase
in the output gap is associated with a decrease in the unemployment rate by a
certain amount.

In the short run, the increase in the money supply leads to an increase in aggregate
demand, which leads to an increase in output and a decrease in the unemployment
rate. This is because the increase in aggregate demand stimulates firms to increase
production, leading to an increase in demand for labor and a decrease in
unemployment.

In the long run, the increase in the money supply leads to an increase in prices, which
reduces the real value of wages. As a result, firms may reduce production, which
could lead to an increase in the unemployment rate. However, the actual impact on
unemployment depends on the degree to which the increase in prices affects wages
and prices across the economy.

Overall, in the short run, Okun's law suggests that the increase in output associated
with the increase in aggregate demand would lead to a decrease in the
unemployment rate. In the long run, the effect on unemployment depends on the
extent to which the increase in prices affects wages and prices across the economy.