A Suppose a Government Decides to Reduce Spending and (Lump-Sum)

Essay

a. Suppose a government decides to reduce spending and (lump-sum) income taxes by the same amount. Using the long-run model of the economy developed in Chapter 3, graphically illustrate the impact of the equal reductions in spending and taxes. Be sure to label:
i. the axes
ii. the curves
iii. the initial equilibrium values
iv. the direction curves shift
v. the terminal equilibrium values.

b. State in words what happens to:
i. the real interest rate
ii. national saving
iii. investment.
iv. consumption
v. output.