Consider an economy characterized by the following equations AE = 10 + 0.75Y – 0.5P AS:

3. Consider an economy characterized by the following equations

AE = 10 + 0.75Y – 0.5P

AS: Y = 10 + P

where Y is national income, AE is desired aggregate expenditure, P is the price level, AS is the aggregate supply. National income is in billions of dollars.

a) What is the equation for the aggregate demand (AD)? Solve for equilibrium P and Y. Illustrate the equilibrium in a diagram with P on the vertical axis and Y on the horizontal axis.(5 marks)

i) Now suppose, all else equal, exports increase by $1.5 billion. What is the new aggregate demand? Solve for the new equilibrium P and Y.(3 marks)

ii) What is the multiplier for this economy when prices are allowed to change?(1 mark)

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