Question

Hello!

Im trying to solve a problem that involves calculating the Fiscal policy multiplier (non-exogenous, that is, depending on the Interest rate):

Task 1: Fiscal policy in the IS - LM model

The following represent demand functions for consumption, investment and money:

C = 80 + 0.8(Y - T) (1)
I = 150 - 1000i (2)
M/P = 0.2Y - 1000i (3)

The price level is constant, the real money supply is 50 units and taxes are independent of income. Government expenditure is 100 units and the government budget (Y - T) is balanced.

a) Determine the equations of the IS and LM curve. Calculate the interest rate and income in equilibrium. Determine the corresponding levels of consumption, savings and investment.
Now assume that the government increases its expenditure to 250 units, with taxes remaining unchanged.

b) Formulate the complete causal chain of the adjustment process to the new equilibrium.

c) Determine interest, income, consumption, savings and investment in the new equilibrium.

d) Derive the government expenditure multiplier. Compare this multiplier with the government expenditure multiplier for exogenous investment.

e) Determine the change in income due to the increase in government expenditure using the government expenditure multiplier(!!!).

I have already found the answers for all the questions but the question e). Nevertheless, I'd be very welcome if you help me by giving me the short results. With question e), I believe I'd have the calculate the Interest rate elasticity of the demand for money, Income elasticity of the demand for money and the Interest rate elasticity of II investments. I should insert these elasticities in the denominator of the non-exogenous Government Expenditure multiplier and then I'd have the value. If Im not mistaken, how should I calculate these elasticities?

Answer 1