C = 100 + 0.5 - (Y – T) I= 200 – 1000 -r where Y is real output and r is the real interest rate. Government purchases and taxes are Ĝ = 300, T = 200. The LM (money market equilibrium) curve is P 101 where P is the price level and i is the nominal interest rate. The Central Bank (CB) is initially supplying M = 2000 units of money, and expected inflation is z“ = 0.02. Assume that the long-run equilibrium level of output is Ÿ = 1000. Short-run equilibrium output is initially at the same level (Y = 1000). Suddenly, news of a new world-beating super-vaccine raises the investment function to I = 250 – 1000 - r 1. Suppose the government (not the CB) wants to stabilise the shock in the long-run, meaning it wants the real interest rate to be the same as before the shock. Explain whether it should increase the government deficit (AĞ > AT) or reduce it (AĞ < AT), and how it works. 2. Suppose the government follows the policy you prescribed above. Explain how the economy would shift from its short-run to long-run equilibrium. In particular, what happens to output Y, the real interest rate r, and prices P during this process?

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Chapter1: Making Economics Decisions
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С - 100 + 0.5- (Ү -Т)
I = 200 – 1000 -r
where Y is real output and r is the real interest rate. Government purchases and taxes are
G = 300, T = 200.
The LM (money market equilibrium) curve is
Y
P
10i
where P is the price level and i is the nominal interest rate. The Central Bank (CB) is initially supplying
M = 2000 units of money, and expected inflation is a = 0.02.
Assume that the long-run equilibrium level of output is Ÿ = 1000. Short-run equilibrium output is initially
at the same level (Y = 1000).
Suddenly, news of a new world-beating super-vaccine raises the investment function to
I = 250 – 1000 - r
1. Suppose the government (not the CB) wants to stabilise the shock in the long-run, meaning it
wants the real interest rate to be the same as before the shock. Explain whether it should increase
the government deficit (AĞ > AŤ) or reduce it (AĞ < AT), and how it works.
2. Suppose the government follows the policy you prescribed above. Explain how the economy would
shift from its short-run to long-run equilibrium. In particular, what happens to output Y, the real
interest rate r, and prices P during this process?
Transcribed Image Text:С - 100 + 0.5- (Ү -Т) I = 200 – 1000 -r where Y is real output and r is the real interest rate. Government purchases and taxes are G = 300, T = 200. The LM (money market equilibrium) curve is Y P 10i where P is the price level and i is the nominal interest rate. The Central Bank (CB) is initially supplying M = 2000 units of money, and expected inflation is a = 0.02. Assume that the long-run equilibrium level of output is Ÿ = 1000. Short-run equilibrium output is initially at the same level (Y = 1000). Suddenly, news of a new world-beating super-vaccine raises the investment function to I = 250 – 1000 - r 1. Suppose the government (not the CB) wants to stabilise the shock in the long-run, meaning it wants the real interest rate to be the same as before the shock. Explain whether it should increase the government deficit (AĞ > AŤ) or reduce it (AĞ < AT), and how it works. 2. Suppose the government follows the policy you prescribed above. Explain how the economy would shift from its short-run to long-run equilibrium. In particular, what happens to output Y, the real interest rate r, and prices P during this process?
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