ECON420HW5ans

# ECON420HW5ans - ECON 420-002 and 004, Fall 2008 Homework 5...

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ECON 420-002 and 004, Fall 2008 Homework 5 Due in class on November 21, 2008 1. (20 points) Consider the economy of Hicksonia. a. The consumption function is given by C = 200 + 0.5(Y-T) The investment function is I = 200-25r Government purchases and taxes are both 100. For the economy, graph the IS cure for r ranging from 0 to 8. Y=200+0.5(Y-100)+200-25r+100 0.5Y=450-25r IS: Y=900-50r b. The money demand function in Hicksonia is (M/P) d = Y – 100r The money supply M is 1000 and the price level is 2. For this economy, graph the LM curve for r ranging from 0 to 8. 1000/2=Y-100*r 500=Y-100r LM: Y=500+100r c. Find the equilibrium income rate r, and the equilibrium level of income, Y. r is determined by the intersection of IS and LM. 900-50r = 500+100r 400=150r r=400/150=2.67 Y=500+100*2.67 = 767 1

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d. Suppose that government purchases are raised from 100 to 150. How does the IS curve shift? What are the new equilibrium interest rate and level of income? IS will shift to the right. Y=200+0.5*(y-100)+200-25r+150 Y=1000-50r The IS Curve will shift to the right. 1000-50r=500+100r 500=150r r=500/150=3.33 Y=1000-50*3.33=867 e. Suppose instead that money is increased from 1000 to 1200. How much does the LM curve shift? What are the new equilibrium interest rate and level of income? 1200/2=Y-100r 600=Y-100r Y=600+100r LM curve will shift down to the right. New Equilibrium income: 900-50r=600+100r New Equilibrium r=300/150=2 f. Derive and graph an equation for the AD curve using a, b and c. What happens to the AD curve if fiscal or monetary policy changes, as in parts (d) and (e)? IS curve: Y=900-50r r=18-0.02Y LM curve: 1000/P = Y-100r r=0.01Y-10/P 18-0.02Y = 0.01Y-10/P 2
0.03Y=18+10/P Y=600+333/P The AD curve will shift to the right with increases in money supply and government spending. 2. (20 points) The Fed is considering two alternative monetary policies: Holding the money supply constant and letting interest rate adjust, or Adjusting the money supply to hold the interest rate constant. In the IS- LM model, which policy will better stabilize output under the following

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## This document was uploaded on 10/28/2011 for the course ECON 420 at UNC.

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ECON420HW5ans - ECON 420-002 and 004, Fall 2008 Homework 5...

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