The following table presents information, at current prices, on the economy of
Timberland:
Exports = 500
Investment = 700
Government Spending = 500
Imports = 0.02Y
Tax = 5 + 0.10Y
Consumption = 150 + 0.8Yd

a) Compute the AE in the economy of Timberland.
b) What is the slope (MPS) of the AE function and what does it imply?
c) What is the equilibrium level of real GDP in the economy?
d) Draw a well-labelled diagram showing this equilibrium point
e) If nominal GDP is $7,010, compute the GDP deflator.
f) Assuming potential GDP is $7,000, how would you describe the output gap?

g) Households are now less sensitive to changes in their income and won't consume as much if their income increased. This sensitivity decreases by 0.1. Compute the new AE and real GDP and show this change on the graph.

h) Draw and label a graph showing the AD, AS and LRAS curves with potential output Y*, equilibrium price P* and also show the equilibrium GDP (the AD and AS intersection) depicting the output gap in (f) above.

i) Describe fully how the market can adjust itself to attain potential GDP without outside interference. Illustrate on the graph drawn for (g).

j) Describe fully how a fiscal policy could help close the gap if the government is impatient to allow the market to adjust itself. Replicate the graph drawn for (g) and illustrate this process.

k) Describe fully how the central bank, as an alternative, can close this gap using the supply of money. Provide a well labelled graph, please.

l) After this change, the interest rate is found to be below the equilibrium interest rate. Describe the effect of this level of interest rate on the price of bonds, the need for cash balances, the opportunity cost for holding money

m) Describe the flow of effects on this level of interest rate on the Goods market (Consumption, Investment, Currency, Net exports, AD and Y)