Question

Exercise 4. The IS curve. (form A3) Consider the following modified version of the IS model. We assume that the categories of GDP expenditure are described by the following equations: • Consumption is described by a =ãch + xcřT, • Investment is described by I! =āj 77 b(r+ — 77, • Government Expenditures by G4 = āGY+GŨY • Imports M = ām • Exports X4 = āxY 1. (2 points) Do you expect the parameter ac to be positive or negative? Briefly, explain the intuition behind your answer. 2. (2 points) Do you expect the parameter xg to be positive or negative? Briefly, explain the intuition behind your answer.

Answer 1

To Gt = DGTL - Z TE TE YE = GTE - XG Yt + XG Tt = (NG+XG) It - XGYE if &GLO, Gt will be a positive function of Yt. That is as Yt rises Gt will rise Gt will rise this will increase aggregale

I demand and Yt in Second round. This way the economy will never more bouck to equilibrium There will be ever increasing inflation and demand Thus, &G must be positive or to Rate interest rate, R output , q