1/7METUDepartment of Economics Econ 202 Macroeconomic Theory Spring 2010 Answers of Problem Set 3 Q.1Assume the following IS-LM model: C = 80 + 2/3Yd; Md= 1/2Y + 400 – 20i; T = 1/4Y + 20; I = 250 – 5i; TR = 80 P = 1; G = 130; Ms= 500a)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 I 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? Multiplier = ∆Y/∆G = 160/100 = 1.6 (the multiplier is reduced)Q.2 ܥ=ܥ+ܿଵሺܻ−ܶሻ; ܫ=ܾ−ܾଵ݅; ሺܯ/ܲሻௗ=݉ଵܻ−݉ଶ݅; ܩܽ݊݀ܶܽݎ݁ܿ݊ݏݐܽ݊ݐ.a)How should the parameters b1, m1, and m2 be interpreted?
b)Use the IS-LM 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.