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1
METU
Department of Economics
Econ 202 Macroeconomic Theory
Instructors: Ebru Voyvoda and
Ş
irin Saraço
ğ
lu
Teaching Assistant: Gizem Ko
ş
ar
20072008 Spring Semester
Problem Set 4 (OB Chapter 5)
PART A: Problems
Question 1
:
Consider the following ISLM model:
C = 1000 + 0.9 Yd
I = 200 + 0.2 Y – 20,000 i
G = 2000
T = (1/3) Y
M
d
= 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
Δ
G = 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
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 Spring '10
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 Macroeconomics, ISLM Model

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