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Unformatted text preview: Macroeconomics 1. Master APE.20102011. PS2 Prof. Xavier Ragot / T.A : Eric Monnet 1 From ISLM to ASAD This exercise helps to get the main intuitions about the ISLM model and the links with ASAD, i.e when the supply side of the economy is included. Give short answers. The answers require only basic calculus but detailed graphs and interpretations. Let's imagine a closed economy that obeys our shortrun ISLM model. Assume it starts out in equilibrium in both the goods market and the money market. This keynesian economy is described by the following set of equations: Goods market: • C = c 0 + c 1 . (1 t ) .Y , where C is consumption; Y is income; t represents a proportional tax; and c0 and c1 are positive constants • I = b b 1 .i , where I is investment; i is the interest rate; and b0 and b1 are positive constants • G = ¯ G , where ¯ G is a positive constant Money market: • Md = P(m0 + m1.Y  m2.i), where Md is money demand; P is the price level; m0 (a positive constant) represents exogenous changes to Md; and m1 and m2 are also positive constants • Let Ms represent the exogenous money supply 1 Combine the goods market equations to derive an expression for Y as a function of i (i.e. derive the IS curve). Give the de nition of the IS relation. 2 Use the money market equations to express i as a function of Y (i.e. derive the LM curve). Give intuition for why the LM curve slopes upward/downward. 1 Macroeconomics 1. Master APE.20102011. PS2 Prof. Xavier Ragot / T.A : Eric Monnet 3 Graph the IS and the LM curves on the same diagram, putting i on the vertical axis and labeling the curves. Label the equilibrium interest rate and output, i and Y , respectively 4. Suppose the government increases its spending by Δ ¯ G . Which curve will shift, if any?...
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 Fall '09
 MrRaggillpol
 Economics, Macroeconomics, Inflation, ISLM Model, Prof. Xavier Ragot, Eric Monnet, Master APE.20102011

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