Tambela Vaughn_ECO-610-X2269 Fiscal & Monetary Policies 15TW2_Module 7 Homework

# Tambela Vaughn_ECO-610-X2269 Fiscal & Monetary Policies 15TW2_Module 7 Homework

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3. Suppose that the investment function is given by I =400 - 2,000R +0.1Y rather than by the investment function given in Chapter 8. Add this investment function to the other four equations of the IS-LM model: Y =C + I +G +X C =220 +0.63Y X =525 -0.1Y -500R M =(0.1583Y -1,000R)P Treat the price level as predetermined at 1.0, and let government spending be 1,200 and the money supply be 900. a. Derive an algebraic expression for the IS curve for this model and plot it to scale. Compare it with the IS curve in the examples of Chapter 8. Which is steeper? Why? On substituting the value of I in the equation, Y = C+400-2000R+0.1Y+G+X Y = 220 +0.63Y +400-2000R+0.1Y+1200+900 = 2740+0.73Y-2000R Equation : Y = 2740+0.73Y-2000R 0.27Y=2740-2000R If Y=1, 0.27=2740-2000R 0.27-2740=-2000R -R=(0.27-2740)/2000 R= 1.369 or 1.37

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Y R 1 1.37 2 2.74 3 4.11 4 5.48 5 6.85 6 8.22 7 9.59 8 10.96 9 12.33 10 13.7 1 2 3 4 5 6 7 8 9 10 0 2 4 6 8 10 12 14 16 Y R This is steeper because for every Y = 1. R= 1.37 b. Derive the aggregate demand curve and plot it to scale. How does it compare with the aggregate demand curve in the example of Chapter 8?
1 2 3 4 5 6 7 8 9 10 0 2 4 6 8 10 12 14 16 Y R The demand curve in this case is kinked, whereas in chapter 8 it was straight. c. Calculate the effect of an increase in government spending on GDP. Is the effect larger or smaller than in the case where investment does not depend on output Y? Describe what is going on. An effect of an increase in government spending from the given value of 1200 to 1500 results in the following: Y = C+400-2000R+0.1Y+G+X Y = 220 +0.63Y +400-2000R+0.1Y+1500+900 Y= 3040+0.73Y-2000R If Y is 1 0.27=3040-2000R -R=(0.27-3040)/2000 R= 1.5199

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In this way, it results in a large effect or an effect proportionate to the increase in government spending. If there is a substantial increase in the government spending it will result in effective increase in the value of R as well. d. Calculate the effect of an increase in the money supply on GDP. How does the impact compare with the situation where investment does not depend on output?
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