Consider the following closed Keynesian economy: Desired consumption and investment are given by: Cd = 200+0.8(Y...

Consider the following closed Keynesian economy:

Desired consumption and investment are given by:
Cd = 200+0.8(Y −T)−500r

Id = 200 − 500r. Taxes and government expenditures are given by

The real money demand is

T = 20+0.25Y G = G=196.

Md
P = 0.5Y − 250(r + πe).

The money supply M = 9890 and the expected inflation πe = 0.10.
(a) Derive the equations for the IS and LM curves and show them on a (Y, r) graph.

(b) If the full-employment output is Y = 1000, what are the equilibrium values of r, P, C and I?

(c) Suppose there is a surprise increase in money supply, M to 12,650, what will be the short-run equilibrium values of Y, r, C and I? What will happen in the long-run? [Hint: Prices are sticky in the short–run (Keynesian)]

(d) If, after the increase in M the government increases its expenditure, what will be your predictions for Y,r,P,C and I? Be specific. [Do not solve for any variable.] Illustrate this on a diagram.

Expert Solution

Rahul Sunny answered 7 months ago

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