1. Desired consumption and investment are cd = 4000-4000r + 0.2Y. I2400 4000r. A
ID: 1117046 • Letter: 1
Question
1. Desired consumption and investment are cd = 4000-4000r + 0.2Y. I2400 4000r. As usual, Y is output and r is the real interest rate. Government purchases are G- 2000. Full-employment output is Y- 10,000. (a) Find the equation of the IS curve. What happens to the IS curve if government purchases rise to 2400? (b) Find the real interest rate that clears the goods market at Y -Y 2. In a particular economy the real money demand function is = 3000 + 0.1 Y-10.000 (r + ) Assume that the nominal money supply is M 6000, the expected inflation rate is e 0.02. and the full-employment output is Y 8000. (a) If the real interest rate that clears the goods market is r = 0.06, what is real money demand? (b) What is the eqilibrium price level that clears the asset market? What happens to the equilibrium price level if there is a 10% increase in the money supply?Explanation / Answer
(1)
(a) In goods market equilibrium, Y = Cd + Id + G
Y = 4000 - 4000r + 0.2Y + 2400 - 4000r + 2000
(1 - 0.2)Y = 8400 - 8000r
0.8Y = 8400 - 8000Y
Y = 10500 - 10000Y [IS equation]
When G = 2400, Increase in G = 2400 - 2000 = 400
Therefore,
0.8Y = 8400 - 8000r + 400
0.8Y = 8800 - 8000r
Y = 11000 - 10000r [New IS equation]
IS curve will shift toward right.
(b) Setting Y = 10000,
10000 = 10500 - 10000r
10000r = 500
r = 0.05 = 5%
NOTE: As per Chegg answering guideline, first question is answered.
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