Assume that an economy's GDP Y=5000. Also assume that the government runs a deficit where tax revenue T=1000 and government expendituresG= 1500. The consumption function is represented by the following equation:
C = 1200+0.25(Y-T)
Investment depends on the interest rate which is represented by the following equation:
I(r) =1500-50r
Assume that nominal money grows at 3%, the demand for real money balances is represented by the following equation:
(m/p)^{D} = 0.2Y-120i
Answer the following questions:
a) In the long run, what will be the equilibrium real interest rate in this economy?
b) Assume that expected inflation rate is the money growth rate. What is the nominal interest rate in this economy?
c) Find the price level in this economy, in the long run.
d) What is the marginal propensity to consume?
e) What proportion of income will individuals want to hold as money?
f) Find the new real interest rate, nominal interest rate, and price level, if the government balances the budget by increasing taxes.