I need help with f. I'm not sure if I did it right.
The economy of this question is initially characterized as follows: T = 0.25Y, C = 100 + Yp, I = 150 + 0.1Y - 1000r + x, G = 200. The IS relation between output, Y, and the risk-free real interest rate, r, is given by:
Y = 450 + 0.6Y - 1000r + x = 2.5x(450 - 1000r + x)
ISY = 1050 - 2500r
where x, the risk premium on business borrowing, is initially 0.03. The economy is initially at full employment equilibrium. The value Ys you computed in part (b) is the economy's potential output, Y. Things have been going so well, however, that people have become cocky. They figure that hardly anyone will default on a loan. The risk premium falls from 3% to 1%, that is, to x = 0.01. The economy expands.
Things equal (5 points each):
i. Investment spending, I, increases because as the risk premium declines, the interest rate, which is r + x, decreases, resulting in higher investment.
ii. Consumption spending, C, increases because due to the increase in economy investment income, C also increases because they are positively related.
iii. The government's budget surplus, TG, increases because