Question

Consumption function: C= 12 + 0.6(YD)

Government spending: G= 20,

Investment function: I= 25-50r,

Tax collections:T=20,

Domestic price level: P = 2,

Nominal money supply: MS= 360,

Real Money Demand: L(r,Y)=2Y-200r,

Production function: Y=N,

Labor supply: N=100

(a) Find an expression for the IS curve.

Y = C + I + G + NX

since there is no foreign sector in the above question, NX = 0. The equation becomes:

Y = C + I G

Y = 12 + 0.6 (Y - 20) + 25 - 50r + 20

0.4 Y = 12 - 12 + 25 - 50R + 20

which gives Y = 1/0.4 (45 - 50r)

Thus, the IS equation becomes: Y = 112.5 - 125r

(b) Find an expression for the LM curve.

L (r, Y) = MS/P

i.e. demand for real balances is equal to real money supply

Thus, 2Y - 200r = 360/2 = 180

which gives Y = 90 + 100r

(c)Find the short-run equilibrium interest rate and output. Represent your results in a graph.

112.5 - 125r = 90 + 100r

which gives r = 0.1 or 10% and Y = 100

ns. Y = 100 and r = 10%

(d) Find an expression for the Aggregate Demand (AD) function.

(e) Find an expression for the Long Run Aggregate Supply (LRAS)function.

(f) What are the long run equilibrium values for output, interest rates, and prices?

(g) Depict (a)-(e) on the IS-LM and AD-LRAS-SRAS diagrams.​​​​​​​

Answer 1