Question

NEED HELP WITH QUESTIONS E TO I
1. Consumption :(-700 +0.95% Investment: I =500-30i Gov't spending: (1=50 Money demandi L(i,Y)=0.75%-30i Money supply : M5/p=400 a) is curre? goods market equilibrium V-C5167 y = 70010.954+500-30 it50 Y-1250+0.959-301 1-0.95%=1250-30i aosy=1250-300 o os 0.05 Y=25000-600L b) LM curve? money market equilibrium LCYP)-MS/P 0.751- 301-400 a. 75Y=400 301 o.AS 0.75 Y=533.33 +40i equilibriom values of income (V) and interest rareso in equilibrium is 4LM 25000-600 i=533.33 +40i. 640i =24466.67 640 640 i = 38.23 Y = 333.33+ (40x38.28) -533.33 + 1529.2 = 2062.53

Consider a hypothetical economy characterized by the following equations(all variables as defined in class).

Consumption: C = 700 + 0.95Y Investment: I=500− 30i
Government spending: G=50
Money demand: L(i,Y )=0.75Y − 30i Money supply: Ms/P=400

(a) What is the equation of the IS curve?

(b) What is the equation for the LM curve?

(c) Solve for the equilibrium values of income (Y) and interest rates (i).

(d) Assume that the government engages in expansionary fiscal policy by increasing

expenditure to G = 100. Solve for the new equilibrium values of income (Y) and interest

rates (i). Illustrate your answer in a graph.

(e) Assume that instead of the expansionary fiscal policy in part (d) above, that the Monetary

Authority (The Central Bank) engages in expansionary monetary policy by increasing the money supply by 100 to Ms/P = 500. Solve for the new equilibrium values of income (Y) and interest rates (i) in this case. Illustrate your answer in a graph.

(f) Whichofthepoliciesfromparts(d)and(e)abovewouldbethemosteffective expansionary policy? Explain.

(g) Say that the government engaged in both of the policies of parts (d) and (e) simultaneously. Would this policy mix be more or less expansionary than the individual policies?

(h) Suppose that money demand in this economy was observed to be income insensitive so that it was now represented by L(i, Y ) = L(i) = 600 − 30i. In this case, which of the policies from parts (d) and (e) above would be the most effective expansionary policy? Explain your answer in terms of the concept of “crowding out”.

(i) Lastly,returningtotheoriginalmodelasinpart(a),supposethatinvestmentwasnow determined to be interest insensitive such that it could be represented by I = 600. In this case, which of the policies from parts (d) and (e) above would be the most effective expansionary policy? Explain this answer in terms of “crowding out”.

Answer 1

gorernmentongay in pantiaay new Ms SOO P monekoy peley New LM cwme eguahon wil be- Liy) 0.75Y-801 -S00 S00 +30 Cso0 +30i 666.66 + 401 y M &dd S autre egns Epuasroy pew 2s7000-6002 66666 666-66 t907 6407 25000 DD94333-3Y =640 24333.39 640 38.02 699-99944M 36-02

666-66 t1520.8 Neiw Y= 2/87.96 Graphially LM 38.22 38.02 IS 2062.8 2187Y6 The menehaoy poliy is mre gfecthe expansionary peliye as it has goreacdery increase In y alerg wrth 4redchen in ntreg a f goremmentngl inoth poliue smultaresly borth neo IS and LMcorre eguaton will 6e used to fund

New Is frem port dY 26000-600 Nw LM fom pat e) y 66-66+40 Equactrng tolth, ue get 666.66+907 26000-6001 26000-666.66 2S7333.39 C2 25433 3 25,333-39 640 1i= 39.58 yo 666-69 t1583. 2 &s BEX Oh t99-999 y 2,249.86 This poligy mix s moe epantionay than the Indivicual policies a it has brope 9 9reater inoreok He Buput ,Y

if mony Indensifve 20y) li 600-30 domand i interet The old Cwithood eanionary poley LM eguaton wil be 600-30 600 -4.00 30 6.66 Pnd Jotol eguilbaium Cat old se will be- Y si00- 6001 y: 29000 600X6-66 ye 27000 - 3996 y 21,60y AfeT fIScal exporshonay peliy y 267000-600x666 y 22/009

fer expantienacy monhy paly LM eguilibium naio 600-301 301 100 1= 30 ie 3.33 Nee , Coth old s nes LM/antexe 2 25G000-6001 2s,a00 -600x3-33 250000-1998 ye y - 23/002 Both Ascal L monotary erpanton neao interst Seate3.33 1S egn y 26000-60o Newo y 24000-60003.33) 26000-1998 Necd Y y- 24r002

IS ALO Sold LMold S-33 21004 У 22,004 23.002 21,002

findercest Ini ensthe meney In care domand M wne esa! horizental. with an expartionary iscal pody only GBP ,y will change as there wi be ho crodig Out effict There will be oroweling aut efeet in Cave of exparronay menatary poley Thus, exparr onary rcal poly as hot Heetre Inrertnast u nterut nentre Thuu, IS eguathen cwill be To0 +O095 +600+50 Y-O.G5Y 1350 3ం Y= 27000

I case of insenthre S wrre ue a rextical S cune have ce eect b pobciel In the Thus, bue can chagram 1S neo neu E E3 Ez y eguitbnum frem part a, and M arupnal S Cnentihire Cuire wth

ffken expantionary Ascal poly IS shif hoSnew and heuo eilbum s EL wrt espartionay monetary poty avd quilbrun shifts frem E 7గల ఆ Szate Full Interut chonge in out effecl crewdrg In car of polrgy mn change in Y 27 bath take place, New egubboum Thl eppantionay Thscal mOt effectre at noreang dP as here es no crowori &ut poltey 4