Consider a closed economy where the goods and money markets are described by the following relationships: C = 200+ 0.9(Y-T) I= 400-15r M Where C is planned consumption, I is planned investment spending, T is government tax revenues, G is government purchases, M is the money supply, P is the price level and r is the interest rate. 1. P a) Derive the two expressions for the IS and LM equilibrium relationships respectively. Sketch a graph of the two relationships. 2. = 200 + Y - 100r b) Calculate the equilibrium value of output Y and interest rate r (round off your answers to one decimal point). Compute also the level of consumption and investment spending in equilibrium and check whether the actua level of spending matches the equilibrium level of output. c) The government reduces taxation to T-50 in order to boost economic activity. Assume no changes in the values of all the other variables. G = 150 T = 100 M = 2000 P = 2 1. 2. d) If the government intends to pursue monetary policy instead of fiscal policy in order to achieve the same leve of output that you computed in c.2), how much should money supply change by? Use graphs to show the change in the economy and explain very carefully the monetary transmission mechanism. What is the immediate increase in income before the economy adjusts to its new equilibrium? What are the economy's equilibrium level of output Y and interest rate following the cut in taxation? Compute the equilibrium level of consumption and investment spending. With the help of the IS/LM graph, carefully explain what happens to the economy following the cut in taxation. e) Suppose that an economist suggests that the equilibrium in the money market should be described by the following equation: M P=37.6+Y-93r With all other behavioural equations as in part (a) (assume that taxation and money supply are at their original level of T = 100 and M = 2000) solve for the equilibrium values of the interest rate and output. Use a graph to show the difference between your result with the one you obtain in b) above. Given the new money market equation, compare the effectiveness of fiscal and monetary policy if, as in c) and d) above, the government reduces taxation to T = 50 or the central bank increases money supply by the amount you derived in d). Comment on your findings.
Consider a closed economy where the goods and money markets are described by the following relationships: C = 200+ 0.9(Y-T) I= 400-15r M Where C is planned consumption, I is planned investment spending, T is government tax revenues, G is government purchases, M is the money supply, P is the price level and r is the interest rate. 1. P a) Derive the two expressions for the IS and LM equilibrium relationships respectively. Sketch a graph of the two relationships. 2. = 200 + Y - 100r b) Calculate the equilibrium value of output Y and interest rate r (round off your answers to one decimal point). Compute also the level of consumption and investment spending in equilibrium and check whether the actua level of spending matches the equilibrium level of output. c) The government reduces taxation to T-50 in order to boost economic activity. Assume no changes in the values of all the other variables. G = 150 T = 100 M = 2000 P = 2 1. 2. d) If the government intends to pursue monetary policy instead of fiscal policy in order to achieve the same leve of output that you computed in c.2), how much should money supply change by? Use graphs to show the change in the economy and explain very carefully the monetary transmission mechanism. What is the immediate increase in income before the economy adjusts to its new equilibrium? What are the economy's equilibrium level of output Y and interest rate following the cut in taxation? Compute the equilibrium level of consumption and investment spending. With the help of the IS/LM graph, carefully explain what happens to the economy following the cut in taxation. e) Suppose that an economist suggests that the equilibrium in the money market should be described by the following equation: M P=37.6+Y-93r With all other behavioural equations as in part (a) (assume that taxation and money supply are at their original level of T = 100 and M = 2000) solve for the equilibrium values of the interest rate and output. Use a graph to show the difference between your result with the one you obtain in b) above. Given the new money market equation, compare the effectiveness of fiscal and monetary policy if, as in c) and d) above, the government reduces taxation to T = 50 or the central bank increases money supply by the amount you derived in d). Comment on your findings.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Sub Parts D and E to be solved please
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