METU
Department of Economics
Econ 202 Macroeconomic Theory
Instructors: Ebru Voyvoda 
Şirin Saraçoğlu
20102011 Spring Semester
Problem Set 3
Question 1:
Assume the following ISLM model:
C = 80 + 2/3Y
d
M
d
= 1/2Y + 400 – 20i
P = 1
T = 1/4Y + 20
G = 130
I = 250 – 5i
M
s
= 500
TR = 80
a)
Derive the IS curve.
b)
Derive the LM curve.
c)
Calculate the equilibrium value of income.
d)
What is the value of the government spending multiplier when interest rates are
assumed to be constant?
e)
Calculate the equilibrium values of investment, tax revenues, and real money
demand.
f)
How much of investment will be crowded out if the government increases its
expenditure by ∆G = 100?
g)
What is the value of the government spending multiplier when interest rates are
allowed to vary?
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View Full DocumentQuestion 2:
Suppose:
C = c
0
+ c
1
(YT)
I = b
0
– b
1
i
(M/P)
d
= m
1
Y – m
2
i
G and T are constant
a)
How should the parameters b
1
, m
1
, and m
2
be interpreted?
b)
Use the ISLM model to graphically determine the effectiveness of fiscal versus
monetary policy when investment is very sensitive to changes in i, and money demand
is very insensitive to changes in i.
c)
Now suppose that the government imposes a tax, t
1
, on income, so that the following
is true:
T = t
0
+t
1
Y, 0<t
1
<1
If money demand is very insensitive to changes in the interest rate, is a decrease in the
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 Spring '10
 tunc
 Macroeconomics, ISLM Model, Monetary Policy, central bank money

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