Question

Use the following information to answer questions.

_C = 1200                     b = .8

I = 600                       c = .1

G = 400                       d = .2

T = 200                       x = .1

NX = -300                  f = 10

r = 10

Y=((C+I+NX)/(1-b))-(b/(1-b))T+(1/(1-b))G-(d/(1-b))f-((c+d+x)/(1-b))r

1. Use this information and solve for equilibrium income. (Show your work)

2. Write down the summary version of the IS curve based on this data.

Answer 1

1. Given, Consumption (C) = 1200 , Investment (I) = 600 , Government Expenditure (G) = 400 , Tax (T) = 200 , Net Export (NX) = -300 , Nominal Rate of Interest (r) = 10, b = .8, c = .1, d = .2, x = .1, f= 10 and the IS curve equation is,

Y = ((C+I+NX)/(1-b)) - (b/(1-b)) T + (1/(1-b)) G -(d/(1-b)) f - ((c+d+x)/(1-b)) r

or, Y = 1/(1-b) [ C + I + NX - bT + G - df - (c+d+x) r ]

here, Y is the income or output in the goods market.

Now, putting the informations given in the IS curve equation we get,

Y = 1/(1 - .8) [ 1200 + 600 - 300 - (.8 * 200) + 400 - (.1+.2+.1) 10 ]

= 1/.2 [ 1500 - 160 + 400 - 4 ]

= 1/.2 [ 1736 ]

= 8680

therefore, the equilibrium income Y is 8680.

2. IS curve gives the combinations of rate of interest and income(or, output) that equilibrates the goods market. Therefore, from the above data we can say that interest rate r = 10 and income Y = 8680 is a combination at which the goods market is in equilibrium, when the consumption, investment, government expenditure, tax and net export are taking the given values.