Question 1: Loanable Funds Theory.

Explain how each of the following affects the supply and demand for loanable funds. Determine what happens to the equilibrium interest rate and the quantity of loanable funds. Illustrate your answer with a drawing of the loanable funds market. Analyze each event independently.

a. Business firms react strongly to the good job news reported last week and are very optimistic the economic expansion will continue.

b. In order to finance the wars in Afghanistan and the Middle East, the government increases borrowing.

c. Consumer spending increases.

Question 2: The Dreaded Multiplier (This question is worth 15 points if correctly answered.)

Suppose Aphid is a closed economy where planned investment spending is $100 and is unaffected by the level of aggregate spending. Furthermore, suppose consumers spend 80% of an increase in their disposable income and autonomous consumer spending equals $200. Aphid currently has net taxes (taxes - transfer payments) of $50. Government spending on goods and services is also $50. (This question is worth 10 points if correctly answered.)

a. Write the equation describing Aphid's Aggregate Planned Expenditure (AE Planned) function.

b. Graph Aphid's AE Planned function. (Remember to include the 45 degree reference line.) Indicate the equilibrium level of income. Find the value of the equilibrium level of income.

c. Using the AE Planned expenditure function from part (a), suppose RGDP or income is 1,000. At an income level or level of production of 1,000, what is the amount of spending in this economy? Describe what is happening to inventories (relative to the desired level of inventories firms want to hold at an production level of 1,000.)

d. Assume planned investment spending increases $100. Write the equation for the new Aggregate Planned Expenditure Function. Graph the original and new AE Planned function. Find the new equilibrium level of income. Did income increase by $100, the increase in planned investment spending? If not, please explain why.

Question 3: Long Run Economic Growth (This question is worth 10 points if correctly answered.)

a. You are the chief economist to the President of Aphid, a small economy. The President asks you to describe the sources of economic growth. You do so below.

b. The President is very serious about encouraging economic growth in Aphid. She asks you to design three policies that would encourage growth in Aphid. She also asks you to explain how your proposed policies would generate economic growth.