Question

Assume the following equations for the goods and money market of an economy:

C = 250 + .8(Y-T)

I = 100 - 50r

T = G = 100.

Ms = 200

Md = 0.2Y – 100r

a) Derive the LM curve from the Md and Ms equations given above. Is this upward or downward sloping? The LM curve is written as Y = __ +/-__r.

b) Using the equation of the original IS curve and the LM curve in part (a) find the equilibrium levels of Y, r, M, C, S, I, G and T.

c) Using the LM curve in part (a) and the IS curve when T falls to 50 and everything else remains the same, find the equilibrium levels of Y, r, M, C, S, I, G and T

d) Explain the adjustment process from the old to the new equilibrium when (1) at the same r, you have a different Y, and (2) at the same Y, you have a different r. You might find it helpful to draw IS and LM curves for both equilibria first. Use numbers as much as possible.

Answer 1