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Problem set 7 F06 - of investment and the equilibrium Y...

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Problem set #7 1. Suppose that the following equations describe the money market: Md/P=0.8Y-16r Ms/P=800 Y=1100 a) Draw the money demand and money supply curves in a simple graph. b) Find the equilibrium interest rate by setting Ms/P=Md/P and solving for r. c) Suppose now that Y increases to Y=1,400. How would this change affect the money market? d) Derive the LM curve graphically. Show on a graph and explain how the changes from part c) would affect the LM curve. 2. Suppose you are given the following information: C=500+0.8Y I=100-3000r G=200 X-M=0 a) Set up the equation of the AE curve by plugging the given numbers in the equation AE=C+I+G+X-M. b) If the real interest rate is 2% (r=0.02), calculate the corresponding level of investment I. Then set AE from part a) equal to Y and solve for Y. Draw a simple graph of the AE and the 45 degree line to illustrate the situation. c) Suppose now that real interest rate increases to 4%. Calculate the level
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Unformatted text preview: of investment and the equilibrium Y again and show the changes on the graph from part a). d) Draw a graph of the relationship between r and Y resulting from parts b) and c). How do we call this curve? e) Suppose now that at the given real interest rate r=0.02 the government increases its spending by 100 to G=300. Show graphically the resulting changes in the AE and the IS curve and explain in words. 3. Suppose that the following equations describe an economy: C=170+0.6Y I=100-4r G=350 Md/P=0.75Y-6r Ms/P=735 a) Derive the equation for the IS curve by setting Y=AE=C+I+G. b) Derive the equation for the LM curve by setting Ms/P=Md/P. c) Calculate the equilibrium levels of Y and r by setting IS=LM. d) If the Fed decides to use expansionary monetary policy, so that Ms increases, what will happen in the IS/LM Model? Explain and show graphically....
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