SEMINAR ANSWERS 7.pdf - Dr Maria Sarigiannidou ES10002 Introductory Macroeconomics Spring 2020 Topic 5 Business Cycles Part II The IS-LM\/AD-AS Model

SEMINAR ANSWERS 7.pdf - Dr Maria Sarigiannidou ES10002...

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Dr Maria Sarigiannidou ES10002 Introductory Macroeconomics Spring 2020 Topic 5 Business Cycles Part II. The IS-LM/AD-AS Model Seminar Questions 7 Answers Page 1 of 8 1. Consider an economy that is described by the following equations: 𝐶 ? = 300 + 0.75(𝑌 − ?) − 300𝑟 ? = 100 + 0.2𝑌 𝐼 ? = 200 − 200𝑟 ? = 0.5𝑌 − 500𝑖 𝑌 ̅ = 2500; 𝐺 = 600; ? = 133,200; 𝜋 ? = 0.05; 𝑃 ?? = 120 In the short run, the price level is fixed at 𝑃 ?? . Find the short-run and long-run equilibrium values of 𝑌, 𝑃, 𝑟, 𝐶, 𝐼 and 𝑖 . Answer Step 1 . We find the equation for the IS curve by using the goods market equilibrium condition: 𝑌 = 𝐶 ? + 𝐼 ? + 𝐺 We have: 𝑌 = {300 + 0.75[𝑌 − (100 + 0.2𝑌)] − 300𝑟} + [200 − 200𝑟] + 600 ⇒ 𝑟 = 2.05 − 0.0008𝑌 (1) This is the IS curve. Step 2 . We find the equation for the LM curve by using the asset market equilibrium condition. a. We first find the equation for the LM curve with an unspecified value of the price level. The money market equilibrium condition equates real money supply to real money demand: ? 𝑃 = ? = 0.5𝑌 − 500𝑖 ? 𝑃 = 0.5𝑌 − 500(𝑟 + 𝜋 ? ) ? 𝑃 = 0.5𝑌 − 500(𝑟 + 0.05) 133,200 𝑃 = 0.5𝑌 − 500(𝑟 + 0.05) ⇒ 𝑟 = 0.001𝑌 − 0.05 − 266.4 𝑃 (2) This is the LM curve for an unspecified value of 𝑃 .