1) Explain how an increase in government borrowing reduces private consumption spending and investment spending.

2) Bart Simpson has a choice between two bonds—Bond A and Bond B. Both bonds have a future value of $1000. Bond A earns 4% interest anually and Bond B earns 6% interest anually and both bonds have a term to maturity of 5 years. Both bonds are discount bonds ,i.e., they don’t pay coupon.

a. Calculate the PV (present value) of the two bonds.

b. Which bond should Bart buy?

c. From this little example, what can you say about the relationship between bond prices and interest rates?