Question

ECO308W Intermediate Macroeconomics Name:

Dr. Schmidt Spring 2019

Quiz #4: IS-LM Equilibrium

The US Macro economy is represented by the following equations:

Financial Sector:

L = Md/P = 0.5Y – 50i Ms/P = 2000

Real Sector:

AD = C+I+G   C = 600 + 0.8YD G = 800 I = 400 – 40i TA = 0.25Y

TR = 250 YD = Y–TA+TR

1. Set up the IS relationship (2 points)

Step 1, convert C to a function of Y; step 2, set AD = C+I+G; step 3, derive IS relation setting Y = AD and solving for Y (note, you are setting up the equation, you can’t solve for i and y until you have the LM curve).

2. Set up the LM relationship (2 points)

3. Solve for equilibrium Y and i using the IS and LM relations (2).

4. If the FED increases the money supply (Ms/P) to 2200, then find the new equilibrium values for Y and i (2).

5. Find the value of Investment (I) for each equilibrium solution (2).

Answer 1

According to the question:

L = Md/P = 0.5 Y -50i

Ms/P =200

AD = C+I+G

C= 600+0.8 Yd

I = 400-40i

G=800

Yd = Y -TA+TR

TA =0.25Y

TR=250

a) IS Market -

AD=Y = 600+0.8 Yd + 800+  400-40i

Y = 600+0.8 (Y -TA+TR) + 800+  400-40i

Y = 600+0.8 (Y -0.25Y+250) + 800+  400-40i

Y = 1800 + 0.6Y +200-40i

Y -0.6Y= 2000 -40i

Y = (2000-40i)/0.4

Y = 5000 - 100i

b) LM Market

L = Md/P = 0.5 Y -50i = Ms/P =200

0.5 Y -50i = 200

0.5 Y = 200+50i

Y = 400 +100i

c) Equilibrium : AD= AS

5000 -100i = 400+100i

4600 = 200i

i=23

Y = 2700

d)

LM Market

L = Md/P = 0.5 Y -50i = Ms/P =220

0.5 Y -50i = 220

0.5 Y = 220+50i

Y = 440+100i

Equilibrium : AD= AS

5000 -100i = 440+100i

4560 = 200i

i=22.8

Y = 2680

e)I = 400-40i

i =23

I = 400-40*23

I=460-920

I= -460

i =22.8

I = 400-40*22.8

I=460-9!2

I= -452