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25 rsubstituting this interest rate1450 200r is or the

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Unformatted text preview: crease in the price level reduces real money balances. r IS LM2 Figure 11–14 LM1 7.25 Interest rate 106 6.0 250 0 250 500 975 1,100 Income, output 1,700 Y To determine the new equilibrium interest rate, equate the IS curve from part (a) with the new LM curve from determine the new equilibrium interest rate, equate the IS curve from To above: part (a) with the new LM curve from above: 1,700 – 100r = 250 + 100r 1,450 = 200r 1,700 – 100r = 250 + 100r 7.25 = r.Substituting this interest rate1,450 = 200r IS or the LM equation, we find into either the 7.25 = r. Y = 975. Substituting this interest rate into either the IS or the LM equation, we find Y is 7.25, Therefore, the new equilibrium interest rate = 975. and the new equilibrium Therefore, the new equilibrium interest rate is 7.25, and the new equilibrium g. level output is is 975, as depicted in Figure 11–14. level of of output975, as depicted in Figure 11–14. The aggregate demand curve is a relationship between the price level and the level of income. To derive is relationship between the price want to the level I income. g. The aggregate demand curvethea aggregate demand curve, we level and solve theof S Toand thetheM equations for Y curve, we want to solve the IS and the LMsubstitute for Y as a derive L aggregate demand as a function of P. That is, we want to equations out for the interest is, we We can substitute out for the interest rate. We M equations for function of P. That rate. want to do this by solving the IS and the L can do this by solving the IS the interesterate: and the LM quations for the interest rate: IS: Y = 1,700 – 100r IS: Y = 1,700 – 100r or 100r = 1,700 – Y 100r = 1,700 – Y. LM: (M/P) = Y – 100r 100r = Y – (M/P). Combining these equations, we we Combining these twotwo equations, findfind and LM: (M/P) = Y – 100r or 100r = Y – (M/P). 1,700 – Y = Y – (M/P) 2Y = 1,700 + M/P Since the nominal money supply M eY = 850 + M/2P.becomes Y = 850 + 500/P. quals 1,000, this Since the nominal money supply M equals 1,000, this becomes 1,700 – Y = Y – (M/P) 2Y = 1,700 + M/P Y = 850 + M/2P. This aggregate demand equation is graphed in+ 500/P11–15. Y = 850 Figure . Chapter 11 Aggregate Demand II 107 This aggregate demand equation is graphed in Figure 11–15. P Figure 11–15 Price level 4.0 2.0 1.0 0.5 0 975 1,100 1,350 Income, output 1,850 Y How does the increase in fiscal policy of part (d) affect the aggregate demand curve? We can see thisHow does the increase in emand curve using the (d)equation from part (d) and the LM curve by deriving the aggregate d fiscal policy of part IS affect the aggregate demand curve?(b): can see this by deriving the aggregate demand curve using the IS equafrom part We tion from part (d) and the LM curve from part (b): IS: Y = 1,900 – 100r or 100r = 1,900 – Y. Y = 1,900 – 100r IS: 100r = 1,900 – Y. LM: (1,000/P) = Y – 100r or 100r = Y – (1,000/P). LM: (1,000/P) = Y – 100r Combining and solving for Y: 1,900 – Y =100r(= Y – (1,000/P). Y – 1,000/P), Combining and solving for Y: Or Y = 950 + 500/P. 1,900 – Y = Y – (1,000/P), or By comparing this new aggregate demand equation to the one previously derived, we can see that the increase in government purchases by=50 shifts theP. Y 950 + 500/ aggregate demand curve to the right by 100. By comparing this new aggregate demand equation to the one previously derived, we can see that the increase in government purchases by 50 shifts the aggregate How does the increase in right by 100. the money supply of part (e) affect the aggregate demand curve? demand curve to the Because How D curve isincrease + M/2P,money supply of part (e) supply the aggregate1,200 the A does the Y = 850 in the the increase in the money affect from 1,000 to causes it to become Because the AD curve is Y = 850 + M/2P, the increase in the demand curve? money supply from 1,000 to 1,200 causes it to become Y = 850 + 600/P. Y = 850 + 600/P. By By comparing this new aggregate demand to the onethe one originally derived, wethe comparing this new aggregate demand curve curve to originally derived, we see that see that the increase in the money supply shifts the aggregate demand curve to increase in the money supply shifts the aggregate demand curve to the right. the right. Chapter 11 P represents 4. a. 7. The IS curve roblem #4 the relationship between the interest rate and the level of income t...
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