A. Derive an equation for the aggregate demand or the IS-curve in this closed economy and derive an expression for the slope of the IS as showing the relationship between interest rate and output B. Derive an equation for the LM curve and derive an expression for the slope of an LM curve and show the relation between interest rate and output C. Find an expression for equilibrium output and interest rates using answers in questions A and B. D. There is a sudden drop in business confidence, and firms decide suddenly to invest less for any level of output and interest rates. From this question onward, the new behavior of firms obeys the following equation: I = b0 A + b₂Y - b₂i with A> 0 Find the new IS relation (call it IS₁). Show graphically the new equilibrium output and interest rates. Call the new equilibrium output Y1. E. Now suppose the government wants to counterbalance the effect of the drop in investors' confidence on GDP using government spending as a policy instrument. Should the government increase or decrease G? What new level of government spending G1 should the government choose to completely offset the effect of lower business confidence? F. Suppose now the government cannot use fiscal instruments (G or T) because Congress would not allow it. The Central Bank decides to use monetary policy to restore the original equilibrium output Yo. Should the Central Bank increase or decrease M₂? Draw the new equilibrium after the change in money supply.
A. Derive an equation for the aggregate demand or the IS-curve in this closed economy and derive an expression for the slope of the IS as showing the relationship between interest rate and output B. Derive an equation for the LM curve and derive an expression for the slope of an LM curve and show the relation between interest rate and output C. Find an expression for equilibrium output and interest rates using answers in questions A and B. D. There is a sudden drop in business confidence, and firms decide suddenly to invest less for any level of output and interest rates. From this question onward, the new behavior of firms obeys the following equation: I = b0 A + b₂Y - b₂i with A> 0 Find the new IS relation (call it IS₁). Show graphically the new equilibrium output and interest rates. Call the new equilibrium output Y1. E. Now suppose the government wants to counterbalance the effect of the drop in investors' confidence on GDP using government spending as a policy instrument. Should the government increase or decrease G? What new level of government spending G1 should the government choose to completely offset the effect of lower business confidence? F. Suppose now the government cannot use fiscal instruments (G or T) because Congress would not allow it. The Central Bank decides to use monetary policy to restore the original equilibrium output Yo. Should the Central Bank increase or decrease M₂? Draw the new equilibrium after the change in money supply.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:QUESTION ONE
Assume that an economy is represented by the following system of equation:
C = C₁ (Y-T)
I = bo + b_Y – bi
Md
P
= C-a *i
G = Go
T = To
Assume that a, bo, b₁,b₂, and c₁ are all positive and that b₁ + b₂ < 1. For simplicity assume that P = 1
Important: Note that unlike in the short run model we have saw in class, money demand depends on
consumption, and not on total output.
A. Derive an equation for the aggregate demand or the IS-curve in this closed economy and derive
an expression for the slope of the IS as showing the relationship between interest rate and output
Derive an equation for the LM curve and derive an expression for the slope of an LM curve and
show the relation between interest rate and output
B.
C. Find an expression for equilibrium output and interest rates using answers in questions A and B.
D. There is a sudden drop in business confidence, and firms decide suddenly to invest less for any
level of output and interest rates. From this question onward, the new behavior of firms obeys
the following equation:
I = b0 A + b₂Y - b₂i with A> 0
Find the new IS relation (call it IS₁). Show graphically the new equilibrium output and interest
rates. Call the new equilibrium output Y1.
E. Now suppose the government wants to counterbalance the effect of the drop in investors'
confidence on GDP using government spending as a policy instrument. Should the government
increase or decrease G? What new level of government spending G1 should the government
choose to completely offset the effect of lower business confidence?
F. Suppose now the government cannot use fiscal instruments (G or T) because Congress would not
allow it. The Central Bank decides to use monetary policy to restore the original equilibrium
output Yo. Should the Central Bank increase or decrease M₂? Draw the new equilibrium after the
change in money supply.
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VIEWStep 2: Determine an equation for AD or IS Curve and the Slope of the IS Curve
VIEWStep 3: Determine an equation for LM Curve and the Slope of the LM Curve
VIEWStep 4: Find an expression for equilibrium output and interest rates
VIEWStep 5: Find the new IS relation
VIEWStep 6: Find new level of government spending G1 and new equilibrium after change in Money Supply
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