a. Use an IS-LM diagram to show the effects on output of a decrease in government spending. Can you tell what happens to investment? Why?

Now consider the following IS-LM model:

b. Solve for equilibrium output when the interest rate is I̅.
Assume c₁ + b₁

c. Solve for equilibrium level of investment.

d. Let’s go behind the scenes in the money market. Introduced equations that describe equilibrium in the money market. Let’s write the equation characterizing the equilibrium as: M/P = d₁Y - d₂i . Solve for the equilibrium level of the real money supply when i = I̅. How does the real money supply vary with government spending?

Transcribed Image Text:

C coc(YT) I = b + bY bi 1= Z=C+I+G 1 = i