HW7 - Sonoma State University Department of Economics...

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Sonoma State University ECONOMICS 304 Department of Economics Florence Bouvet Assignment 7 Due Date: December 10 th at the beginning of lecture 1) Deriving IS Curve: Suppose an economy is characterized in the short run by the following set of equations, with a fixed price level Investment demand: I = 2000 - 6000r Consumption demand: C = 600 + 0.6(Y-T) Government: G = 3000, T = 3000 Where Y is total income (and total expenditure, and production), C is consumption, I investment, G government purchases, T taxes. a) Interpret the investment function above in words. What type of behavior does it imply for firms carrying out investment in this economy? (Remember the story from the lecture on the Neoclassical model in chapter 3.) b) Derive a formula for the IS curve, expressing r as a function of Y. (You will need a calculator for this.) Graph it (indicate the slope and y-intercept).

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c) Suppose that there is a drop in taxes by 10% (T falls from 3000 to 2700). How does this affect the IS curve? Compute the new IS curve equation and graph it on same diagram as part b.
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