Question

Consider the following economy: Planned consumption: ? = 900 + 0.5(? − ?) − 180? Planned investment: ? = 950 − 180? Real money demand: ( ? ? ) ? = 0.5? − 180?

a. (2 pts) Suppose ? = 400, ? = 450, and ? = 9,750. Find an equation for the IS curve.

b. (2 pts) Find an equation for the LM curve.

c. (2 pts) Find an equation for the aggregate demand curve. Express the AD curve as ? being a function of ?. (Hint: Use the IS and LM equations to find a relationship between ? and ?.)

d. (5 pts) If the full employment output ? = 4,000, what are the equilibrium values for the level of aggregate prices, output, consumption, investment, and the real interest rate?

e. (2 pts) Suppose that the money supply falls to ? = 5,250. What is the equation for the AD now?

f. (5 pts) Repeat (d) given that money supply falls to 5,250

g. (3 pts) Explain what you find using the IS-LM diagram, and the LRAS curves drawn in the ? − ? space. Argue whether IS, LM shifted or not and why

PLEASE ONLY ANSWER E- F

Answer 1

The IS curve would be where or or or or or or or .

The LM curve would be where or or or or .

The AD would be as or , and the equilibrium price would be as where or .

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(e) For the new money supply, we have the new LM curve as or or or or or pr . The new AD would be where the new LM and IS interact, ie where or or or .

(f) The LRAS would be as . The new equilibrium price would be where the new AD interacts with the LRAS, ie where or or pr or .

The equilibrium output (which would be equal to the LRAS, ie Y*=4000) would be as or or pr .

For the IS curve be , the equilibrium real interest rate would be as or or or .

The equilibrium consumption would be as or or or .

The equilibrium investment would be as or or or .

(g) The graph is as below.

The IS curve remains unaffected. LM curve, yet affected, but does not shifts. The IS curve deals with real output Y and real interest rate r, and both doesn't change in either scenario, hence remains unaffected.

LM curve deals with r, Y and price level P. The LM curve is surely affected by the change in the money supply, but is the change in price level absorbs that and the LM remains the same as before, ie the shift in LM due to decrease in money supply is reversed by the proportionate decrease in price level.