Consider an IS-LM model where the central bank sets the nominal interest rate. The consumption and investment functions are given by C = 200 + 0.25(Y – T) I = 150 + 0.25Y – 1000i. and suppose that government expenditures and taxes are given by G = 250 and T = 200. respectively. Let real money demand be given by MIP = 2Y – 8000i. and let the initial interest rate be io = 0.05. (a' - . Solve for the equilibrium values of output and real money supply. (b) Solve for the equilibrium values of C and I, and verify that consumption, investment and government expenditures indeed add up to output Y. (c) Now suppose that interest rate is cut to ig = 0.03. Solve for the new equilibrium values of Y, MIP, C and I. What are the effects of this change on the economy? Provide brief intuition. (d) Set the interest rate back to ig = 0.05. Now suppose that govemment spending increases to G = 400. If the central bank keeps the interest rate unchanged, how should monetary supply respond to this expansionary fiscal policy? What are the effects of this fiscal expansion on Y and C? Explain.

Consider an IS-LM model where the central bank sets the nominal interest rate. The consumption and investment functions are given by C = 200 + 0.25(Y – T) I = 150 + 0.25Y – 1000i. and suppose that government expenditures and taxes are given by G = 250 and T = 200. respectively. Let real money demand be given by MIP = 2Y – 8000i. and let the initial interest rate be io = 0.05. (a' - . Solve for the equilibrium values of output and real money supply. (b) Solve for the equilibrium values of C and I, and verify that consumption, investment and government expenditures indeed add up to output Y. (c) Now suppose that interest rate is cut to ig = 0.03. Solve for the new equilibrium values of Y, MIP, C and I. What are the effects of this change on the economy? Provide brief intuition. (d) Set the interest rate back to ig = 0.05. Now suppose that govemment spending increases to G = 400. If the central bank keeps the interest rate unchanged, how should monetary supply respond to this expansionary fiscal policy? What are the effects of this fiscal expansion on Y and C? Explain.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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