Macroeconomics
Macroeconomics
10th Edition
ISBN: 9780134896441
Author: ABEL, Andrew B., BERNANKE, Ben, CROUSHORE, Dean Darrell
Publisher: PEARSON
Question
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Chapter 11, Problem 3NP

a.

To determine

To describe: The equation of IS curve, as per Keynesian closed economy theory.

a.

Expert Solution
Check Mark

Answer to Problem 3NP

The equation for IS curve will be Y=1500-1666.67r .

Explanation of Solution

Given data:

    ConsumptionC=388+0.4(Y-T)-600r
    InvestmentI=352-400r
    Government purchasesG=280
    TaxesT=300
    Full employment output Y¯ =1400
    Money supplyM=12,600
    Real money demandL=1,750+0.75Y-8,750(r+πe)
    Expected inflationπe=0.02

The IS curve equation in the following manner:

  Y=Cd+Id+G

Substitute values from above,

  C=388+0.4(Y-T)-600rI=352-400rG=280T=300

Then,

  Y=388+0.4(Y-300)-600r+352-400r+280Y=388+0.4Y-120-600r+352-400r+280Y-0.4Y=388-120+352-1000r+2800.6Y=900-1000r

Or, Y=1500-1666.67r

Equivalently, r=0.9-0.0006Y

b.

To determine

To describe: The equation of LM curve in the short run, while the price level remains fixed at Psr=7 .

b.

Expert Solution
Check Mark

Answer to Problem 3NP

The equation for LM curve will be Y=300-11,666.67r .

Explanation of Solution

  MP=L126007=1750+0.75Y-8750(r+0.02)1800=1750+0.75Y-8750r-175225=0.75Y-8750r0.75Y=225+8750r

Or, Y=300+11666.67r

Equivalently, r=-0.0257143+0.0000857143Y

Or, r= -9350+335000Y

c.

To determine

To describe: The new output levels, real interest rate, consumption and investment.

c.

Expert Solution
Check Mark

Answer to Problem 3NP

The new output level is 1,350 , real interest rate is 9% , consumption is 754 and investment is 316 .

Explanation of Solution

The equilibrium of short run is achieved at a point where the curves IS and LM intersect each other.

Now, we shall equate both the equations,

  Y=1500-1666.67rY=300+11666.67r

On solving these two equations, we get,

  r=0.09 and placing value of r in equation I=352-400r

We get,

  I=316

Then, we get

  Y=1350C=754

d.

To determine

To describe: The new output levels, real interest rate, consumption, investment and price level for long run.

d.

Expert Solution
Check Mark

Answer to Problem 3NP

The new output level is 1400 , real interest rate is 6% , consumption is 792 and investment is 328 and price level for long run is 6 .

Explanation of Solution

The real interest rate can be calculated as follows:

  Y=1500-1666.67r1400=1500-1666.67r

We get,

  r=0.06

As the price is variable in the long run, the new LM curve can be derived as follows:

  MP=L12600P=1750+0.75Y-8750(r+πc)12600P=1750+0.75Y-8750(r+0.02)12600P=1750+0.75Y-8750r-1750.75Y=12600P-1575+8750r

The results will be as follows:

Substitute value of r=0.06 , in equation I=352-400r

We get,

  I=328

Substitute, given values: Y¯=1400 and T=300 in equation 388+0.4(Y-T)-600r

We get, C=792 and then P=6

e.

To determine

To describe: The velocity value in the equilibrium of long run.

e.

Expert Solution
Check Mark

Answer to Problem 3NP

The velocity value in the equilibrium of long run is 0.66 .

Explanation of Solution

According to the quantity theory of money;

  M×V=P×Q

Now, substitute the value of M=12,600 and P=6 in the above equation.

We get,

  12,600×V=6×1,400V=0.66

f.

To determine

To describe:

If G=350 and investment (I)=320 , price level (P) = 6 and inflation rate (π)=0.02 , the level of taxes (T) and money supply (M), to achieve this long run equilibrium.

f.

Expert Solution
Check Mark

Answer to Problem 3NP

The level of taxes (T) is 425 and money supply (M) is 11,550 , will achieve this long run equilibrium

Explanation of Solution

When I = 320 , the real interest rate, r will be:

  320=352400r400r=32r=0.08

With the proposed conditions, the long run IS curve equation will turn out as follows:

  Y=Cd+Id+G1400=388+0.4(1400-T)-600r+320+3501400=388+560-.04T-600X0.08+320+3500.4T=388+560-48+320+350-14000.4T=170T=425

Now,

  0.75Y=M6-1575+8750(0.08)

Substitute Y=1400 we get,

  1925=M6M=11,550

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