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Macro1 PS2

# Macro1 PS2 - Macroeconomics 1 Master APE.2010-2011 PS2 Prof...

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Unformatted text preview: Macroeconomics 1. Master APE.2010-2011. PS2 Prof. Xavier Ragot / T.A : Eric Monnet 1 From IS-LM to AS-AD This exercise helps to get the main intuitions about the IS-LM model and the links with AS-AD, 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 short-run IS-LM 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.2010-2011. 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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Macro1 PS2 - Macroeconomics 1 Master APE.2010-2011 PS2 Prof...

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