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Practice Proble IS-LM - Econ 301 C Autumn 2016 Practice...

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Econ 301 C Autumn 2016 Practice Problem: IS-LM Model Consider an economy with the following relationships C = c o + c 1 Y D I = b o + b 1 Y - b 2 i (a) Derive the IS relation. What determines the slope of the IS curve? (b) If CB sets i = . 05, how is the decision represented in the equations? (c) if c o = 200 , c 1 = . 25 , b o = 150 , b 1 = . 25 , b 2 = 1000 , G = 250 , T = 200 what is the equilibrium Y? For all parts below use the same parameter values (d) What is the level of real money supply when i = . 05 given that the money demand curve is given by : M d = 2 Y - 8000 i (e) Now suppose FED changes nominal interest rate to i = . 03. How does it change the LM curve? How does equilibrium output change? What should be the change in money supply to achieve this interest rate change? (f) Let i = . 05 as before. Now suppose G increases to 400. Summarize effects on Y, I and C (g) What is the effect of expansionary fiscal policy on real money supply? (h) Something extra to think about (we partially discussed this in class): Suppose that instead of setting the interest rate and allowing the money supply to adjust, the FED set the money supply and allows interest rate to adjust to clear the money market equilibrium. What would the LM curve now look like. What would cause a shift in the LM curve. What factors would cause the LM curve to be flatter or steeper? 1
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Brief Solution (This AK doesn’t include any graphs. But in an exam you will need to draw appropriately labeled graphs) (a) Derive the IS relation. What determines the slope of the IS curve?
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