Scenario 1:G rises, no accommodation by the Fed, locate the new equilibrium as point B on all three diagrams, being sure to label your diagrams completely. Show and explain the crowding out that Barro discusses in the "Government Spending is no Free Lunch" article. In particular, we are assuming total crowdingso that Y does not change, along with the assumption of a closed economy. Be sure to explicitly identify the crowding out on the consumption function and investment demand functions that you drew above.8

Scenario 2:G rises, the fed completely accommodates the shock to money demand so that interest rates remain unchanged (identical to the Romer assumption). Show this development as point C on all three diagrams. b.(5 points) In the Romer paper, the multipliers that they use assume that the Fed will keep interest rates constant for the foreseeable future. Referring to your diagrams, does this assumption increase/decrease/ or have no effect on the estimated spending multiplier? Explain. 2.(25 points total) Consider the following modeli) C = 1500 + mpc (Y - tY)ii) I = 800iii) G = 500iv) X - M = 500 - mpi (Y)where:t = the (flat) tax ratempc = the marginal propensity to consumempi = the marginal propensity to importsuppose mpc = .80, t = .25, mpi = .2a.(5 points) solve for the equilibrium output equate C+I+G+X-M = Y1500+.8 (.75Y) +800+500+500-.2Y = Y.6Y= 3300Y= 3300/.6=5500b.(5 points) Solve for the (government) spending multiplier.The G multiplier is given as Y( 1 –mpc(1-t) +mpi) = 1500 +800 +G +500so change in Y/ change in G = multiplier = (1-mpc(1-t)+mpi)9

=1/.6 = 1.667 c.(10 points) When we discussed the multiplier we discussed the impact effect. For example, suppose that G increases by 100 to 600 and we assume, as we often do, that firms match the increase in demand by increasing Y by 100. In round two, this is an increase in income of 100 to consumers. Trace out exactly where this 100 increase in income goes in the second round and compare to oursimpler treatment with a closed economy and lump sum taxes. Hint, there are three leakages to address(again, please be very specific as to where the 100 increase income 'goes' in this second round). The rise in G is a one time increase. It causes a rise in AD , that leads to rise in Y level. In round 2, this new Y increases C, which again feeds to AD. the rise in Y and C continues till a new equilibrium is found..When firms also match the rise in G by a rise in Y we can see that it has an effect on C. This is because C is related to Y and t. The rise in Y causes GDP to rise but after 3 leakages:imports through the mpitaxes as disposable income is based on income taxessavings through the marginal propensity to save= 0.2(5 points) What would happen to the multiplier if the mpi rises to .25. Please explain the intuition. the new multiplier=1/0.65 =1.5384615=================================================================True/False (40 points total - 2 points each)1)Unemployment benefits are an example of fiscal policy.