Question

(16 marks total) Using the IS-LM model discussed in chapter 10, suppose you’re given the following information: • The consumption function is given by C = 40 + 0.5 (Y − T). • The investment function is given by I = 150 − 10r. • T = 120, and G = 170. (a) Find planned expenditure P E as a function of Y and r. (b) For the case where r = 8, find the value of Y that produces equilibrium in the goods market. Draw a Keynesian cross diagram that shows graphically how this Y is determined. Be sure to clearly label all axes, curves, intercepts, slopes, and the equilibrium. (c) Find the IS curve using the Keynesian cross approach. In particular, rearrange the goods market equilibrium condition to find the equilibrium value of r as a function of Y . Then, in a graph with Y on the horizontal axis and r on the vertical axis, plot this IS relationship. Be sure to clearly label all axes, intercepts, and slopes. (d) Suppose T decreases to 100. For any given value of r, how much does Y change? What is the tax multiplier? (e) In response to the decrease in T from part (d), does the IS curve shift? If so, in what direction and by how much? Show this graphically (you can draw a new graph, or use the same graph you drew in part (c)).

Answer 1