1. Using the IS-LM model and assuming the central bank conducts monetary policy by directly setting the interest rate for liquid funds in short-term money market, explain the effect on the equilibrium level of aggregate income and the interest rate of the following:

(A) an expansionary fiscal policy;

(B) a restrictive monetary policy.

2. Explain how the equilibrium level of output and employment is determined in the Keynesian income-expenditure model (or multiplier model). Then explain how the model overcomes objections to a fiscal policy of a deficit-financed expansion in government spending to reduce any labour unemployment on the grounds of ‘crowding out'.