11 1. In this question, we will make a series of changes to the assumptions underlying the AD curve to examine how the shapes of the IS, LM, and AD curves are affected. Start by assuming that the demand side of the economy is characterized as it was in class by C, = cd (Y, G, Y+1 G:+1,84), 1, = Id (1,,A,+1,K), Y, = C, +1, +G M = P.M (r, +1+1, Y.), r; = i; 1+1 (a) Graphically derive the IS, LM, and AD curves as we did in class. (b) Suppose the first equation above is replaced with C = Cd (Y, - G, Y,+1 - G:+1). That is, assume that desired consumption no longer depends on the real interest rate. All other equations hold as in part (a). Graphically derive the new AD curve. (c) Does an exogenous increase in the money supply M, shift the AD curve by more if the economy is characterized as in part (a) or as in part (b)? Show this result graphically. (d) Now instead assume that money demand depends only on real income Y,. That is, replace the fourth equation characterizing the demand side of the economy with M = P,Md (Y) All other equations hold as in part (a). Graphically derive the new LM and AD curves. (e) Now instead assume that money demand depends only on the expected nominal interest rate i, = r, ++1. That is, replace the fourth equation characterizing the demand side of the economy with M, = P,Md (r, ++1). All other equations hold as in part (a). Graphically derive the new LM and AD curves. (f) Does a positive IS shock (an increase in A+1 or G, or a decrease in G+1) shift the AD curve by more if the economy is characterized as in part (d) or as in part (e)? Show this result graphically. = 11 1. In this question, we will make a series of changes to the assumptions underlying the AD curve to examine how the shapes of the IS, LM, and AD curves are affected. Start by assuming that the demand side of the economy is characterized as it was in class by C, = cd (Y, G, Y+1 G:+1,84), 1, = Id (1,,A,+1,K), Y, = C, +1, +G M = P.M (r, +1+1, Y.), r; = i; 1+1 (a) Graphically derive the IS, LM, and AD curves as we did in class. (b) Suppose the first equation above is replaced with C = Cd (Y, - G, Y,+1 - G:+1). That is, assume that desired consumption no longer depends on the real interest rate. All other equations hold as in part (a). Graphically derive the new AD curve. (c) Does an exogenous increase in the money supply M, shift the AD curve by more if the economy is characterized as in part (a) or as in part (b)? Show this result graphically. (d) Now instead assume that money demand depends only on real income Y,. That is, replace the fourth equation characterizing the demand side of the economy with M = P,Md (Y) All other equations hold as in part (a). Graphically derive the new LM and AD curves. (e) Now instead assume that money demand depends only on the expected nominal interest rate i, = r, ++1. That is, replace the fourth equation characterizing the demand side of the economy with M, = P,Md (r, ++1). All other equations hold as in part (a). Graphically derive the new LM and AD curves. (f) Does a positive IS shock (an increase in A+1 or G, or a decrease in G+1) shift the AD curve by more if the economy is characterized as in part (d) or as in part (e)? Show this result graphically. =