3. Consider the following Keynesian closed economy:

π

π

( )

( ) = + − −

= −

=

=

=

=

= +

− +

=

C Y T r I r G

T Y

M L Y r

Consumption 388 0.4 600 .

Investment 352 400 .

Government purchases 280.

Taxes 300.

Full-employmentoutput 1400.

Money supply 12,600.

Realmoneydemand 1750 0.75 8750 .

Expected inflation 0.02.

e e

a. What is the equation of the IS curve?

b. Suppose that the price level is fixed at = P 7 sr in the short run. What is the equation of the LM curve in the short run, while the price level remains fixed?

c. What are the short-run equilibrium values of output, the real interest rate, consumption, and investment?

d. What are the long-run equilibrium values of out put, the real interest rate, consumption, invest ment, and the price level?

e. What is the value of velocity in long-run equilibrium?

f. Suppose that the government wants to increase its purchases to = G 350 and to achieve a long-run equilibrium with investment, I, equal to 320, and the price level, P, equal to 6. What level of taxes, T, and money supply, M, will achieve this long-run equilibrium? The following questions will guide you to the answer. (1) What value of the real inter est rate leads to = I 320? (2) What is the value of consumption in long-run equilibrium when

= I 320 and = G 350? (3) What value of taxes, T, will lead to the level of consumption, C, in part (2), thereby achieving = I 320 and = G 350 in long run equilibrium? (4) What value of the nominal money supply, M, will lead to a price level of 6 in long-run equilibrium with = I 320 and = G 350?

(Note: continue to assume that π =0.02. e )