Question

Consider a hypothetical economy where: • C(Yd) = 105 + 0.8 × (Y − T) • I(r) = 74 − 1 × r • G = 65 • T = 50 1. Using the information above, write out the planned Aggregate Expenditure equation. 2. Write down an expression for the Investment-Savings (IS) Curve. 3. Assume that inflation is zero, so that i = r. This economy’s central bank follows a given Monetary Policy Rule: r = i = 0.003 × Y + 0.001 × P where P is the price level. Given this and the expression for the IS Curve, write down an expression for the Aggregate Demand Curve. 4. Suppose that the price level (P) is 1000. What is the equilibrium value of aggregate income, Y ? 5. What are the equilibrium values of the interest rate, r, and investment, I? 6. Suppose that the price level (P) falls to 500. What is the equilibrium value of aggregate income, Y ? 7. What are the new equilibrium values of the interest rate, r, and investment, I? 8. Discuss why the change in the price level has the identified impacts on Y , r and I

ONLY ANWSER QUESTION 8

Answer 1

Price level is the average of current price in the economy including goods and services all together. In other words price level is the price of goods, services in an economy.

Change in Price level and Y: When the price level changes (increases or decreases) the output level also changes(increases or decreases). When the price level increases the people demand less due to higher price, so the production in the economy decreases Y. When price level decreases the people in the economy demand more goods and services which leads to higher production leasds to increase in Y.

Change in Price level and r(interest rate): As discussed earlier decrease in price level increases Y. To produce Y producer borrowed from the market for which they have to paid certain interest rate. For this average interest rate in the economy decreases. Like this when price level increases the increase in interest rate.

Change in Price level and I(Investment): As discussed, decrease in price level decreases in interest rate. Decreases in interest rate increase investment demand. If there is an increase in price level the interest rate increases which leads to decrease in investment demand.