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MT2_AK_B-1 - Econ 102 Answer key for 2nd midterm Josef...

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Econ 102 - Answer key for 2nd midterm Josef Schroth, February 27, 2009 Part B 1. Remember the equation for the goods market, Y = c 0 + mpc ( Y - T 0 ) + I 0 - I 1 r + G 0 . Solving for r gives us the IS curve r = c 0 - mpcT 0 + G 0 + I 0 I 1 - 1 - mpc I 1 Y . We see that the IS curve is flat if I 1 is large. I.e. if investment demand is very sensitive to the interest rate then there will be a large change in output following a change in the interest rate through the investment channel. If you show this using graphs you will get full points as well. 2. Remember the equation for the money market, M P = l 0 - l i r + l Y Y . Solving for r gives us the LM curve r = l 0 l i - 1 l i M P + l Y l i Y . We see that the LM curve is flat if l i is large. I.e. if money demand is very sensitive to the interest rate then a large change in Y (for a given money supply) will cause only a small increase in r . If you show this using graphs you will get full points as well. 3. Here we have Δ c 0 < 0. We can use the IS curve to substitute for r in the LM curve and 1
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