How to Finance Government Spending

Consider a closed economy where consumption spending depends on output: $C = C_0 + 0.8 Y_d$, where $C_0 > 0$ is autonomous consumption and $Y_d$ is disposable income (income after tax). The tax rate is flat at the level of 20% on all income without double taxation. The ShortRun Aggregate Supply (SRAS) is flat at $P=1$. Investment is given by $I = 7.5 - 4r$, where $r$ is the real interest rate expressed in percentage points (for example, $r = 1.12$ means that interest rate is 1.12%, not 112%). The supply of loanable funds is given by $S = 16r$. Initially, the equilibrium level of GDP $Y^* = 100$, all demand for loanable funds comes from investment, the state budget is balanced. The government wants to reduce unemployment and increases $G$ by 10.

(a) (10 rp) Assume that the government just has this money at its disposal, so there is no need to borrow it or find elsewhere. How will the increase in $G$ affect GDP? If the increase in GDP does not equal to the increase in $G$, explain the difference.