Econ 102: Fall 2007
Discussion Section Handout #12
“Imagination is more important than knowledge!”-by Albert Einstein.
Problem #1: Aggregate Demand
Saving the Jupiter
(Continued from last time) Careful as he is, Michael was kidnapped (We’ve said: Use your
imagination!). There is a reason why Michael is kidnapped! The economy in Jupiter is experiencing a
severe recession. Though technically advanced, they don’t have any good economist. And there in this
blue planet they found Michael and the 100 dollar bill in his pocket…
The economy in the Jupiter is described by (take the planet in its entirety as a closed economy):
Y = C + I + G,
C = 2,000 + 0.5(Y-T),
I = 10,000 – 40,000r,
G = 2,000,
T=0.2Y
And the supply and demand in the money market (sorry we don’t know the name of their currency
yet…)
M
s
=1,000
M
d
= 5,000 – 20,000r
Where r is the interest rate written as a decimal (e.g., if the interest rate r equals 10% then it would
appear in the equation as 0.1) and the required reserve ratio for demand deposit is 20%.
(a) Find the equilibrium interest rate
M
s
= M
d
=> 1000 = 5,000 – 20,000r => r = 0.20
(b) Find the equilibrium investment level
I = 10,000 – 40,000*0.20= 2,000
(c) Find the equilibrium output level
Y = (2,000 + 0.5(Y-0.2Y)) + 2000 + 2000 = 6,000 + 0.4Y
=> 0.6Y = 6,000
=> Y=10,000
(d) Suppose that the potential GDP (or full employment GDP) is 20,000, if you were Michael (He will tell
you how fun it is on Jupiter), what suggestion would you have for the central bank of Jupiter, assuming