1METU Department of Economics Econ 202 Macroeconomic Theory Instructors: Ebru Voyvoda and Şirin Saraçoğlu Teaching Assistant: Gizem Koşar 2007-2008 Spring Semester Problem Set 4 (OB Chapter 5) PART A: ProblemsQuestion 1:Consider the following IS-LM model:C = 1000 + 0.9 Yd I = 200 + 0.2 Y – 20,000 i G = 2000 T = (1/3) Y Md= Y – 100,000 i M/P = 6000 a)Derive the equation for the IS curve. b)What is the general definition of the IS curve? c)What is the equation that describes the LM curve. d)What is the general definition of the LM curve? e)What are the equilibrium values of real income and the interest rate? f)Solve for the equilibrium values of C and I. Verify that your answer for Y is correct by adding C, I and G. g)Describe in words the conditions that are satisfied at the intersection of the IS and LM curves, and explain why this is an equilibrium. h)Increase G by 100 and solve for the new values of Y and i. Also, solve for C and I. Explain the effects of expansionary fiscal policy using your results to illustrate. i)What is the value of the government spending multiplier which corresponds to the spending multiplier of Chapter 3? j)By how much does an increase in government spending of ΔG = 100 increase the level of income in this model, which includes the money market? k)Explain the difference between your answers to (i) and (j). l)Leave G equal to 2000 and suppose that the central bank engages in a 40 YTL million worth of open market purchase. Also suppose that people hold 20% of their money in currency and the required reserve ratio is 25%. Solve for the new values for Y, I, C, and I. Explain the effects of expansionary monetary policy using your results to illustrate.