Question

Suppose that economy of Portugal is characterized by the following C = 200 + 0.5 (Y - T) Represents the consumption function I = 600 – 30 r represents the investment function G = 300 represents the public spending T = 300 represents the level of taxation (m/p)d = y - 40 r represents the money demand function (m/p)s = 1500 r represents the real money supply d Y represents the global output Find the IS curve the LM curve and deduce the equilibrium level of interest rate equilibrium level of income. The government increases the money supply by 100. How does it affect the equilibrium level of income? Justify your answer. Calculate the new equilibrium …. Equilibrium level of income

Answer 1

1. IS curve:

Y = C + I + G

Y = 200 + 0.5(Y - 300) + 600 - 30r + 300

Y = 1100 + 0.5Y - 150 - 30r

0.5Y = 950 - 30r

LM Curve:

Money demand = Money supply

y - 40r = 1500

y = 1500 + 40r

Put value of y in IS equation:

0.5Y = 950 - 30r

0.5(1500 + 40r) = 950 - 30r

750 + 20r = 950 - 30r

50r = 200

r = 200/50

r = 4%

Y = 1500 + 40r = 1500 + 40 x 4

Y = 1500 + 160

Y = 1660

2. Change in Y = Change in G/(1 - MPC) = 100/(1 - 0.5) = 100/0.5 = 200

New equilibrium income = Y + Change in Y = 1660 + 200 = 1860