Question 1
The economy is currently in its long-run equilibrium. However, there are evidences indicating that there is an increase in (autonomous) consumption.
a) According to the long-run classical model of a closed economy, what would happen to the economy’s output, real interest rate and investment? Support your answer by an appropriate diagram.
b) Suppose the government finds the change in real interest rate in part (a) undesirable and wants to maintain the real interest rate at the initial level, what policy would you recommend the government to pursue? Explain how the recommended policy could achieve the goal of the government. Also, how does this recommended policy affect the country’s output, real interest rate, and investment? Use the diagram your drew in part (a) to support your answer and discuss the magnitudes of changes of the above macroeconomic variables after your recommended policy is implemented (compare your answer in part (b) to your answer in part
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