A
NSWERS TO
A
SSIGNMENT
2
Section I: Multiple Choice Questions
1.
C
2.
C
3.
C
4.
B
5.
B
6.
D
7.
A
8.
B
9.
B
10.
B
11.
A
12.
D
Section II: Short Answer Questions
Question 1
a) The IS curve connects all (r,Y) pairs that represent equilibria in the goods
market.
By definition, planned expenditure is:
E = C + I + G + GX – IM
Substituting
in all the equations given in the question we have:
E = A + MPE*Y
The term A is decomposed into two terms: the baseline level of autonomous
expenditure and the term that depends on r:
A = = A
0
– (
I
r
+
X
ε
ε
r
)r
The goods market is in equilibrium when planned expenditure (or aggregate
demand) is equal to real GDP (or national income):
Y = E
Combining all these equations we get the IS curve:
Y = A
0
/(1MPE) – (
I
r
+
X
ε
ε
r
)r/(1MPE)
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The LM curve gives you all pairs (i,Y) that represent equilibria in the money
market.
The demand for real money balances is:
M
D
/P = L
0
+ L
y
Y  L
i
(r +
π
e
)
The supply of nominal money by the central Bank is M. The money market is in
equilibrium when
M
D
= M. Using this and solving for M we get the LM curve:
Y =
(1/L
y
) *(M/P
 L
0
) + (L
i
/L
y
)*(r +
π
e
)
The economy is in SR equilibrium when the IS and LM curves intersect. See
Fig.1
(
Note
: if you get a question like this you do not have to do more calculations than
those above
).
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 Winter '09
 TASSO
 Macroeconomics, Inflation

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