Question
1. According to the IS-LM model, what happens to the interest rate, income, consumption and investment under the following circumstances? Use graphs to explain a.
1. According to the IS-LM model, what happens to the interest rate, income, consumption
and investment under the following circumstances? Use graphs to explain
a. The central bank increases the money supply. (4marks)
b. The government increases government purchases. (4marks)
c. The government increases taxes. (4marks)
2. Consider the economy of Hicksonia.
a. C=300+0.50(Y-T)
The investment function is I=100-20t
Government purchases and taxes are both 150.For this economy, use a graph to illustrate
the LM curve for r ranging from 0 to 8. (4marks)
b. The money demand function in Hicksonia is
(M/P)d = Y-150r
The money supply M is 1,000 and the price level P is 2. For this economy, use a graph to
illustrate the LM curve for r ranging from 0 to 8. (4marks)
c. Calculate the equilibrium interest rate and the equilibrium level of income Y.
(4marks)
d. Suppose the government purchases are raised from 150 to 200. How much does
the IS curve shift? Calculate the new equilibrium interest rate and level of
income? (3marks)
e. Suppose instead that the money supply is raised from 1,000 to 1,200. How much
does the LM curve shift? Calculate are the new equilibrium interest rate and level
of income? (3marks)
f. With the initial values of monetary and fiscal policy, suppose that the price level
rises from 2 to 4. Explain the impacts. Calculate are the new equilibrium interest
rate and level of income? (2marks)
g. Derive and graph an equation for the aggregate demand curve. Describe what
happens to this aggregate demand curve if fiscal or monetary policy changes, as in
parts (d) and (e)? (8marks)
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