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Chapter 10 Exercise 4

# Chapter 10 Exercise 4 - 125 0.75(Y – T 200 – 10 r 150 E...

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Mankiw, Chapter 10, Exercise #4, (6 th Edition) Given the following model, find the equation for the IS curve. Y= C + I + G C = 125 + 0.75 (Y – T) I = 200 – 10r G = 150 T = 100 According to the Keynesian model, we know that equilibrium occurs somewhere along the 45-degree line (the slope of this line is 1). This is where Planned Expenditures (E) are equal to Actual Expenditures (Y). In addition to the mode given above, we also know that E = Y in equilibrium. We can use the same concepts used in previous exercises. The only difference is that we want to find the equation for the IS curve. We know this equation provides us with a relationship between the real interest rate (r) and the level of income (Y) in the goods market. E = C + I + G E = [

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Unformatted text preview: 125 + 0.75 (Y – T) ] + [ 200 – 10 r ] + [ 150 ] E = 125 + 0.75 (Y – 100) + [200 – 10 r] + 150 E = 475 + 0.75 Y – 0.75 (100) – 10 r E = 400 + 0.75 Y – 10 r Since E = Y in equilibrium, then Y = 400 + 0.75 Y – 10 r Y – 0.75 Y = 400 – 10 r 0.25 Y = 400 – 10 r Y = [1 / 0.25] [400 – 10 r] Y = 4 [400 – 10 r] Y = 1600 – 40 r {This is the equation for the IS Curve} If we examine the components of this equation, we can see that changes in Fiscal Policy (government spending and taxes) have an effect on the IS curve. When either G, T or both change, they cause a SHIFT in the IS curve. When government spending increases, the IS shifts right. When taxes decrease the IS curve also shifts right. Think about the opposite case....
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