1.  Consider the following long-run model:
Real GDP (Y) = 5,000 Consumption (C) = 200 + 0.7 (Y-T)
Investment (I) = 1,000 -50r  where r is the real interest rate.
Taxes (T) are 1,000 and government spending (G) is 1,250
a) What are the equilibrium values of C, I and r?  (Answers:  3,000 , 750 , 5)
b) What are the values of private saving, public saving and national saving?  (Answers:  1,000, -250, 750)
c) Redo (a) and (b) given real GDP=5500.
d) Redo (a) and (b) given C=50+0.7 (Y-T).

2.  Suppose the government moves to reduce the budget deficit.  Using the model in question 1, graphically illustrate the impact of reducing the government's budget deficit by increasing (lump-sum) taxes on household income.  State in words what happens to the real interest rate, national saving, investment, consumption and output.

3.  Suppose a government education program succeeds in getting households to save more (you may interpret this as a downward shift in the consumption function).  Using the model in question 1, graphically illustrate the impact of the higher saving rate by households. State in words what happens to the real interest rate, national saving, investment, consumption and output.

4.  Suppose consumption depends negatively on the real interest rate.
a)  What does this imply about the substitution effect (of changes in interest rates on consumption) relative to the income effect?  What does this suggest in terms of the relationship between private savings and the real interest rate?  
b)  Do you think your answers to questions 2 and 3 will change?  Show this graphically using the market for loanable funds (and keep in mind what kind of relationship there is now between private savings and the real interest rate).

5.  Suppose the government creates a new investment credit for firms that does not directly impact government's tax revenue. 
a)  How will the investment credit affect the investment curve? 
a)  Is this credit going to increase the level of investment?  Show (using the market for loanable funds) the effects on the level of investment for two scenarios: (i) consumption does not depend on the real interest rate and (ii) consumption depends negatively on the interest rate.

6.  Many economists have advocated a shift from income taxes towards consumption taxes in order to increase total savings in the U.S. economy. 
a)  Suppose the federal government imposes a national sales tax (a consumption tax).  What are your predictions with respect to the effects on consumption, private savings, public savings, national savings and investment.
b)  Suppose the government reduced income taxes by as much as the government would collect in sales tax revenue (revenue neutral proposal).  What would happen to investment and the real interest rate?  Show this graphically.