6. Launao The following equations describe an economy. C = 50 + 0.75 (Y-T). 1 15

ID: 1111849 • Letter: 6

Question

6. Launao The following equations describe an economy. C = 50 + 0.75 (Y-T). 1 150-10 r. (M/P) Y-50r G = 250. T= 200. M = 3,000. p = 4. a. Identify each of the variables and briefly explain their meaning b. From the above list, use the relevant set of equations to derive the IS curve. Graph the IS curve on an appropriately labeled graph c. From the above list, use the relevant set of equations to derive the LM curve. Graph the LM curve on the same graph you used in part (b). d. What are the equilibrium level of income and the eguilibrium interest rate?

Explanation / Answer

( M/P)d = Y – 50r is the equation of money market where ( M/P)d stands for demand for real money as a function of income level, Y and interest rate, r. M denotes the money supply level and P stands for price level.

The given equation Y =C + I + G gives equilibrium in the goods market. The locus of all the equilibrium points in the goods market gives a downward sloping IS curve.

The equation (M/P)d = Y – 50r represents equilibrium condition in a money market. The locus of all equilibriums in money market gives an upward sloping LM curve.

Substituting their respective values,

Y = 50 + 0.75(Y – 200) + 150 – 10r + 250

Y – 0.75Y = 300 -10r

0.25Y + 10r = 300 ............................................(1)

( M/P)d = Y – 50r

Substituting respective values,

Y – 50r =750 ................................................(2)

Solve (1) and (2) simultaneously then we get equilibrium values of Y and r as

Y = 1000 and r = 5%

Y =C + I + G is the equation for AD curve. The variable Y is the income, C stands for consumption expenditure which is a function of disposable income, (Y-T). I stands for investment expenditure and is a function of interest rate and G stands for government expenditure.