Question

**3. The IS-LM Model**

Consider an economy characterized by the following equations for consumption (C), investment (I), government spending (G), taxes (T), aggregate demand (Z), output (Y), and the interest rate (i):

C = 54 + 0.3*(Y – T)

I = 16 + 0.1*Y – 300*i

G = 35

T = 30

Z = C + I + G

i = ?

Suppose the central bank has set the interest rate equal to 2% (this is, ? = 0.02).

a) Find the equation for the IS relation. Find the equilibrium levels of output (Y*), consumption (C*), and investment (I*), and check that C*, I*, and G add up to Y*.

Suppose the government increases its spending by 6 to G’ = 41.

b) Find the equation for the new IS relation. Find the new equilibrium level of output (Y**). What is the value of the multiplier in this economy?

c) Find the new equilibrium levels of consumption (C**) and investment (I**). Explain intuitively why, despite the fact that public saving (T–G) went down, investment (if you did the math right) has actually gone up.

Suppose now that government spending remains at its original level of G = 35. Consider a drop-in consumer and business confidence that changes the consumption and investment equations to:

C = 44 + 0.3*(Y – T)

I = 8 + 0.1*Y – 300*i

d) Find the new equilibrium level of output (Y***).

e) Can the government reverse the effects of this decline in consumer and business confidence and restore the original output level Y* using fiscal policy alone (i.e., with no change in monetary policy)? If so, how much of a change in G (call it ?G) would it take? Explain.

As an alternative to raising G by ?G, could the government accomplish its goal (restoring Y*) by lowering taxes T by this same amount (?G) instead? Why or why not? Explain.

f) Can the central bank reverse the effects of this drop-in consumer and business confidence and restore the original output level Y* using monetary policy alone (i.e., with no change in fiscal policy)? If so, how much of a change in the interest rate ? would be necessary? Explain.

g) Propose a fiscal-monetary policy mix (i.e.: a simultaneous change in G and/or T and in ?) that accomplishes the goal of returning the economy to its original output level Y*.

*****Please answer questions D thru G**

Answer #1

3. The IS-LM Model
Consider an economy characterized by the following equations for
consumption (C), investment (I), government spending (G), taxes
(T), aggregate demand (Z), output (Y), and the interest rate
(i):
C = 54 + 0.3*(Y – T)
I = 16 + 0.1*Y – 300*i
G = 35
T = 30
Z = C + I + G
i = ?
Suppose the central bank has set the interest rate equal to 2%
(this is, ? = 0.02).
a)...

Suppose that the economy is characterized by the consumption
function C=151+ 0.1(Y-T) with exogenous investment I = 10,
government purchases G = 20, and taxes T = 10. Which of the
following is true?
the multiplier is 0.9
the equilibrium consumption/output ratio is C/Y = 0.9
the autonomous spending is 170.
equilibrium output is Y = 200
the government budget is balanced

1. Suppose the United States economy is represented by the
following equations: Z= C + I + G , C = 500 + 0.5Yd, Yd = Y − T T =
600, I = 300, G = 2000, Where, Z is demand for goods and services,
Yd is disposable income, T is taxes, I is investment and G is
government spending. Y is income/production. (a) Assume that the
economy is in equilibrium. What does it mean in terms of the...

. Suppose an economy is represented by the following
equations.
Consumption function C = 200 + 0.8Yd
Planned investment I = 400
Government spending G = 600
Exports EX = 200
Imports IM = 0.1Yd
Autonomous Taxes T = 500
Marginal Tax Rate t=0.2
Planned aggregate expenditure AE = C + I + G + (EX - IM)
By using the above information calculate the equilibrium level
of income for this economy and explain why fiscal policy becomes
less effective...

Consider an economy in which taxes, planned investment,
government spending on goods and services, and net exports are
autonomous, but consumption and planned investment change as the
interest rate changes. You are given the following information
concerning autonomous consumption, the marginal propensity to
consume, planned investment, government purchases of goods and
services, and net exports:
Ca = 1,500 – 10r; c = 0.6; Ta = 1,800; Ip = 2,400 – 50r; G =
2,000; NX = -200
(a)Derive Ep and...

. Suppose an economy is represented by the following
equations.
Consumption
function
C = 200 + 0.8Yd
Planned
investment
I = 400
Government
spending
G = 600
Exports
EX = 200
Imports
IM = 0.1Yd
Autonomous
Taxes
T = 500
Marginal Tax
Rate
t=0.2
Planned aggregate
expenditure AE = C
+ I + G + (EX - IM)
By using the above information calculate the equilibrium level
of income for this economy and explain why fiscal policy becomes
less effective...

2) Consider the following Keynesian model of the economy.
Consumption Function: C = 12 + .6 Y d,
Investment Function: I = 25 − 50 r,
Government Spending: G = 20,
Tax Collections: T = 20,
Money Demand Function: L d = 2 Y − 200 r,
Money Supply: M = 360,
Price Level: P = 2.
a) Find an expression for the IS curve and plot it.
b) Find an expression for the LM curve and plot it.
c)...

In a closed economy, given the following:
The consumption function C = 0.8(1 – 0.25) Y +
12
The average tax rate t = 25%
The level of private investment I = 26
The level of government spending G = 14
Where Y is the national income.
Calculate the equilibrium level of income and output in the
economy.
Calculate the expenditure multiplier and show the effect
of
an increase in government spending and
an increase in private investment.

Let: C = consumption, Ip = investment spending (as a function of
price level), G = government spending, Tx = tax revenue, Yd =
after-tax income, Assume for a given closed economy: C=100 + 0.9 Yd
– 20P Ip= 400 – 40P G=300 T=100 Moreover, aggregate supply curve
for this economy is defined by the following equation: P=1.41 +
0.0001Y
a. According to the investment equation (Ip= 400 – 40P) as
overall price level in the economy increases investment spending...

Let: C = consumption, Ip = investment spending (as a function of
price level), G = government spending, Tx = tax revenue, Yd =
after-tax income, Assume for a given closed economy: C=100 + 0.9 Yd
– 20P Ip= 400 – 40P G=300 T=100 Moreover, aggregate supply curve
for this economy is defined by the following equation: P=1.41 +
0.0001Y a. (10 points) According to the investment equation (Ip=
400 – 40P) as overall price level in the economy increases...

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