Question

Given the following information about a closed economy.
Consumption C=100+0.8Y
Investment I = 1200-30r
where r is the interest rate Y is Income.
The precautionary and speculative demand for money is as follows.
MD1=0.25Y
MD2 = 1375-25r
Money supply Ms =2500
a) find the equilibrium values of Y and​ r.
b) Assume that a budget is now introduced in to the economy and that consumption is given by
C= 100+0.75Yd
Yd=Y-T
T=20+0.2Y
if government expenditure G = 935
i) find the new equilibrium values of Y and r
ii) show how a decrease of 43.75 in the autonomous part of speculative demand for money function will affect​ Y and r.
iii) If starting from the position of b above the autonomous part of the consumption function decreases by 35 show how this shift in the schedule will affect Y and r (use diagramatic exposition)

Answer 1

Answer:

If the autonomous part of the consuption falls by 35 units then the equilibrium income falls from 5100 to 5050 units and equilibrium interest rate also falls from form 6% to 5.5%. As can be seen fronm the diagram a fall in consumption will lead to shifing of the aggregate expenditure(C+I+G) curve downwards from C+I+G to new C'+I+G. New equilibrium is at point E' where equilibrium income is 5050 units

In money narket, a fall in income due to fall consumption leads to a decrease in precautionary demand of money which shifts the money demand curve to left from MD to MD'. As a result, equilibrium moves from point E to E and equilibrium interest rate falls from 6% to 5.5%..