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f01_ps3ans

# f01_ps3ans - Solutions to Problem Set 3 1 a False an...

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Solutions to Problem Set 3 1. a. False : an increase in G shifts the IS to the right, Y and i , so C because income has increased, but the effect on I is ambiguous. b. Uncertain : Y but the interest rate could go up or down depending on the entity of the shifts and the slopes of the IS and LM. c. True : the reduction of the fiscal deficit is pursued through a G or an T , both policy shift the IS to the left, the i and Y , and the I (no effect of Y ) d. False : with banks the CB controls only indirectly the Ms 2. a .d0 : output sensitivity (sales) of investment d1 : interest sensitivity of investment Y = [1/(1-c1-d0)]{c0 - c1T + G} - [d1/(1-c1-d0)]i Or in the i-Y space : i = {c0 - c1T + G}/d1 - [(1-c1-d0)/d1]Y b. slope = - [(1-c1-d0)/d1] c. the larger is the interest sensitivity of investment, the flatter is the IS, thus a small reduction of i has a large impact on I and therefore on Y. a. e : income sensitivity of Md f : interest sensitivity of Md b. the slope is (e/f) c.

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