Question

1. Suppose that the MPC=.75. If the government was to increase equilibrium output by $10,000, by how much should they increase government spending?

2. This question considers the link between the IS-LM model and the AD-AS model.  

Suppose the Fed increases the money supply. This causes the _________ curve to shift _______, which causes aggregate demand to shift ___________. Finally, equilibrium output _________ as a result.

3.Use the IS-LM diagram to answer the following: If the Fed increases the money supply, then in the short run national income will _________, the interest rate will ___________.

4. Suppose an economy is represented by the following equations:

C=500+.75(Y-T)

I=1000 -50r

(M/P)d=Y-200r

G=1000

T=1000

M=6000

P=2

Use these equations to derive both the IS and LM curves.  

Suppose that a newly elected president cuts taxes by 20%. Assuming that the money supply is held constant, what is the equilibrium interest rate in this economy? Round your answer to the nearest tenth. Do not use a percent sign when entering your answer. Your answer should not be given as a proportion (if you think the answer is that r=23% then you would input 23 rather than .23, for example).

5. Suppose an economy is represented by the following set of equations:

C=500+.75(Y-T)

I=1000 -50r

(M/P)d=Y-200r

G=1000

T=1000

M=6000

P=2

Use these equations to derive both the IS and LM curves.  

Suppose that a newly elected president cuts taxes by 20%. Assuming that the money supply is held constant, what is the equilibrium output in this economy?

Answer 1

1)

Expenditure Multiplier value = 1/1-MPC

= 1/1-0.75

= 1/0.25

=4

Expenditure*4 = 10,000

Expenditure = 10, 000 /4

= $ 2500

Government should increase expenditure by $ 2500

2)

Suppose the Fed increases the money supply. This causes the LM curve to shift Right, which causes aggregate demand to shift Right. Finally, equilibrium output Increases as a result.