3. Was Out . Consider the economy of Hicksonia. a. The consumption function is given by C = 300 + 0.6(Y - T). The investment function is I = 700 - 80r. Government purchases and taxes are both 500. For this economy, graph the IS curve for r ranging from 0 to 8 percent. b. The money demand function in Hicksonia is (M/P) = Y - 200r. The money supply M is 3,000, and the price level P is 3. Graph the LM curve for r ranging from 0 to 8 percent. c. Find the equilibrium interest rate r and equilibrium income Y. d. Suppose that government purchases increase from 500 to 700. How does the IS curve shift? What are the new equilibrium interest rate and income? e. Suppose instead that the money supply expands from 3,000 to 4,500. How does the LM curve. shift? What are the new equilibrium interest rate and income? f. With the initial values for monetary and fiscal policy, suppose the price level rises from 3 to 5. What happens? What are the new equilibrium interest rate and income? g. For the initial value of monetary and fiscal policy, derive and graph an equation for the aggregate demand curve. What happens to this aggregate demand curve if fiscal or monetary policy changes, as in parts (d) and (e)?Preview File Edit View Go Tools Window Help Q 8 0 Sat Apr 8 7:48 AM chapter 13.pdf Page 1 of 3 1 Q Q 1 2 . ' A Q Search X + chapter 13.pdf 330 | PART IV Business Cycle Theory: The Economy in the Short Run Q Search SUMMARY 1. The IS-LM model is a general theory of the balances, lowers the interest rate, and stimulates aggregate demand for goods and services. The investment spending, thereby raising equilibrium exogenous variables in the model are fiscal policy, income. monetary policy, and the price level. The model 4. Expansionary fiscal policy-an increase 1 explains two endogenous variables: the interest in government purchases or a decrease in rate and national income. taxes-shifts the IS curve to the right. This shift 2. The IS curve represents the negative relationship in the IS curve increases the interest rate and between the interest rate and income that arises income. The increase in income represents a from equilibrium in the market for goods and rightward shift in the aggregate demand curve. services. The LM curve represents the positive Similarly, contractionary fiscal policy shifts the relationship between the interest rate and income IS curve to the left, lowers the interest rate and that arises from equilibrium in the market for income, and shifts the aggregate demand curve real money balances. Equilibrium in the IS-LM to the left. model-the intersection of the IS and LM 5. Expansionary monetary policy shifts the LM 2 curves--represents simultaneous equilibrium curve downward. This shift in the LM curve in the market for goods and services and in the lowers the interest rate and raises income. The Cancel Op market for real money balances. increase in income represents a rightward 3. The aggregate demand curve summarizes the shift of the aggregate demand curve. Similarly, results from the IS-LM model by showing contractionary monetary policy shifts the LM equilibrium income at any given price level. curve upward, raises the interest rate, lowers Show All X The aggregate demand curve slopes downward income, and shifts the aggregate demand curve because a lower price level increases real money to the left. IMG_5652 jpeg pt 5 PM KEY CONCEPTS IMG_1667.HEIC twoljpg 7BE280E-3C47-4 Argument _6251.jpeg -F3EDG3AF- ReMup_002556 Mapping.ent.dack Screen SAof025567881G 1888 HEIC IMG_ 2022-0...32.56 PM IMG_1883.HEIC APR 8 4 ? pg.s 2-yQKEY CONCEPTS Monetary transmission Pigou effect Liquidity trap mechanism Debt-deflation theory QUESTIONS FOR REVIEW 1. Explain why the aggregate demand curve slopes 3. What is the impact of a decrease in the money supply on downward. the interest rate, income, consumption, and investment? 2. What is the impact of an increase in taxes on the 4. Describe the possible effects of falling prices on interest rate, income, consumption, and investment? equilibrium income. PROBLEMS AND APPLICATIONS 1. According to the IS-LM model, what happens in the short run to the interest rate, income, consumption, c. The government increases taxes. and investment under the following circumstances? d. The government increases government purchases Be sure your answer includes an appropriate graph. and taxes by equal amounts. a. The central bank increases the money supply. 2. Use the IS-LM model to predict the short-run b. The government increases government purchases. effects of each of the following shocks on income, the interest rate, consumption, and investment. In each330 | PART IV Business Cycle Theory: The Economy in the Short Run SUMMARY 1. The IS-LM model is a general theory of the balances, lowers the interest rate, and stimulates aggregate demand for goods and services. The investment spending, thereby raising equilibrium exogenous variables in the model are fiscal policy, income. monetary policy, and the price level. The model 4. Expansionary fiscal policy-an increase explains two endogenous variables: the interest in government purchases or a decrease in rate and national income. taxes-shifts the IS curve to the right. This shift 2. The IS curve represents the negative relationship in the IS curve increases the interest rate and between the interest rate and income that arises income. The increase in income represents a from equilibrium in the market for goods and rightward shift in the aggregate demand curve. services. The LM curve represents the positive Similarly, contractionary fiscal policy shifts the relationship between the interest rate and income IS curve to the left, lowers the interest rate and that arises from equilibrium in the market for income, and shifts the aggregate demand curve real money balances. Equilibrium in the IS-LM to the left. model-the intersection of the IS and LM 5. Expansionary monetary policy shifts the LM curves--represents simultaneous equilibrium curve downward. This shift in the LM curve in the market for goods and services and in the lowers the interest rate and raises income. The market for real money balances. increase in income represents a rightward 3. The aggregate demand curve summarizes the shift of the aggregate demand curve. Similarly, results from the IS-LM model by showing contractionary monetary policy shifts the LM equilibrium income at any given price level. curve upward, raises the interest rate, lowers The aggregate demand curve slopes downward income, and shifts the aggregate demand curve because a lower price level increases real money to the left. KEY CONCEPTSKEY CONCEPTS Monetary transmission Pigou effect Liquidity trap mechanism Debt-deflation theory QUESTIONS FOR REVIEW 1. Explain why the aggregate demand curve slopes 3. What is the impact of a decrease in the money supply on downward. the interest rate, income, consumption, and investment? 2. What is the impact of an increase in taxes on the 4. Describe the possible effects of falling prices on interest rate, income, consumption, and investment? equilibrium income. PROBLEMS AND APPLICATIONS 1. According to the IS-LM model, what happens in the short run to the interest rate, income, consumption, c. The government increases taxes. and investment under the following circumstances? d. The government increases government purchases Be sure your answer includes an appropriate graph. and taxes by equal amounts. a. The central bank increases the money supply. 2. Use the IS-LM model to predict the short-run b. The government increases government purchases. effects of each of the following shocks on income, the interest rate, consumption, and investment. In eachCHAPTER 13 Aggregate Demand II: Applying the IS-LM Model | 331 case, explain what the Fed should do to keep income at its initial level. Be sure to use a graph in each of 4. Pa Work It Out . An economy is initially described by your answers. the following equations: a. After a new high-speed computer chip is invented, C = 500 + 0.75(Y - T) many firms decide to upgrade their computer I = 1,000 - 50r systems. b. A wave of credit card fraud increases the M/P = Y - 200r frequency with which people make transactions G = 1,000 in cash. T = 1,000 c. A bestseller titled Retire Rich convinces the public to increase the percentage of their income M = 6,000 devoted to saving. P = 2. d. The appointment of a new dovish Fed chair increases expected inflation. a. Derive and graph the IS curve and the LM curve. Calculate the equilibrium interest rate and 3. We Out . Consider the economy of Hicksonia. income. Label the equilibrium point A on your a. The consumption function is given by graph. b. Suppose a newly elected president cuts taxes by C = 300 + 0.6(Y - T). 20 percent. Assuming that the money supply The investment function is is held constant, what are the new equilibrium interest rate and income? What is the tax I = 700 - 80r. multiplier? c. Now assume that the central bank adjusts the Government purchases and taxes are both 500. money supply to hold the interest rate constant. For this economy, graph the IS curve for r ranging What is the new equilibrium income? What from 0 to 8 percent. must the new money supply be? What is the tax b. The money demand function in Hicksonia is multiplier?CHAPTER 13 Aggregate Demand II: Applying the IS-LM Model | 331 case, explain what the Fed should do to keep income at its initial level. Be sure to use a graph in each of 4. Pa Work It Out . An economy is initially described by your answers. the following equations: a. After a new high-speed computer chip is invented, C = 500 + 0.75(Y - T') many firms decide to upgrade their computer I = 1,000 - 50r systems. b. A wave of credit card fraud increases the M/P = Y - 200r frequency with which people make transactions G = 1,000 in cash. T = 1,000 c. A bestseller titled Retire Rich convinces the public to increase the percentage of their income M = 6,000 devoted to saving. P = 2. d. The appointment of a new dovish Fed chair increases expected inflation. a. Derive and graph the IS curve and the LM curve. Calculate the equilibrium interest rate and 3. W. Out . Consider the economy of Hicksonia. income. Label the equilibrium point A on your a. The consumption function is given by graph. b. Suppose a newly elected president cuts taxes by C = 300 + 0.6(Y - T). 20 percent. Assuming that the money supply The investment function is is held constant, what are the new equilibrium interest rate and income? What is the tax I = 700 - 80r. multiplier? c. Now assume that the central bank adjusts the Government purchases and taxes are both 500. money supply to hold the interest rate constant. For this economy, graph the IS curve for r ranging What is the new equilibrium income? What from 0 to 8 percent. must the new money supply be? What is the tax b. The money demand function in Hicksonia is multiplier? (M/P) = Y - 200r. d. Now assume that the central bank adjusts the money supply to hold income constant. What The m ly M is 3.000 is the new equilibrium interest rate? WhatPreview .0. chapter 13 ,pdf 3 l | _62'ji .1 Mme IMtLr an! v chapter 13.ndf Page 2 of 3 c. Tools Window Help I =700-80r. Government purchases and names are both 500. For this economy. graph the IS curve for ranging from 0 to 3 percent. The money demand function in Hicksonia is (M/m' = y 200:. The money supply M is 3.000. and the price level P is 3. Graph the LMcui-ve for r ranging from 0 to 8 percent. Find the equilibrium interest rate rand equilibrium income Y. - SuPpose that government purchases increase from 500 to 700. How does the IS curve shift? What are the new equilibrium interest rate and income? ' suPPOR instead that the money supplyr CXPm'l' mm 3.000 to 4,500. How does the LM cum, Shift? What are the new equilibrium interest rate and income? With the initial values for monetary 3m! scal poliqr, suppose the price level rises Earn 3 to 5. What happens? What are the new equilibrium Interest rate and income? lit)? the initial value of monetary and scal Polity. derive and graph an equation for the _ \"RICE-re demand curve. What hlecm '0 \"m 333351: demand curve if scal or moneul'y 1'\"th changes, as in parts (:1) and (c)? QQEI] vD'Q~ interest rate and income? What is the tax multiplier? c. Now assume that the central bank adjusts the mney supply to hold the interest rate constant. What is the new equilibrium income? What must the new money supply be? What is the tax multiplier? (1. Now assume that the central bank adjusts the money supply to hold income constant. What is the new equilibrium interest rate? What must the money supply be? What is the tax multiplier? 0. Show the equilibria you calculated in pan (b), (c). and (d) on the graph you drew in part. (3}. Label them point: B, C, and D. 5, Determine whether each of the following statements is true or false and explain why. For each true sratement. discuss whether there is anything unusual about the impact of monetary and scal policy in that special case. a. ll' immanent does not depend on the interest rate, an L\" curve is horizontal. b. If investment does not depend on the interest rate, the IS curve is vertical. c. If money demand does not depend on the interest rate. the IS curve is horizontal. d. If money demand does not depend on the amen\" rate. the UM curve is vertical. 3 If money demand does not depend on incomeI ' the LM curve is horizontal. Cancel Preview File Edit View Go Tools Window Help Q 8 0 Sat Apr 8 7:50 AM chapter 13.pdf Page 3 of 3 1 Q Q L g V D' A QV Search X + chapter 13.pdf 332 | PART IV Business Cycle Theory: The Economy in the Short Run f. If money demand is extremely sensitive to the where a > 0 and 0 0 and d > 0. The parameter d measures achieve this goal? the sensitivity of investment to the interest rate, and b. In the early 1980s, the U.S. government cut taxes the parameter c is a constant that is sometimes called and ran a budget deficit, while the Fed pursued tous investment. a tight monetary policy. What effect should this . Solve for Y as a function of r, the exogenous policy mix have? variables G and T, and the model's parameters a, b, 7. Use the IS-LM diagram to describe both the short- c. and d. run effects and the long-run effects of the following b. How does the slope of the IS curve depend changes on national income, the interest rate, the on the parameter d, the interest sensitivity of price level, consumption ent, and real money investment? Refer to your answer to part (a) and balances. explain the intuition. a. An increase in the money supply . Which will cause a bigger horizontal shift in the b. An increase in government purchases IS curve: a $100 tax cut or a $100 increase in c. An increase in taxe ment spending? Refer to your answer to part (a) and explain the intuition 8. The Fed is considering two alternative policies: Now suppose demand for real money balances is a inear function of income and the interest rate: Holding the money supply constant and letting the interest rate adjust L(r, Y ) = eY - fr. . Adjusting the money supply to hold the interest where e > 0 and f > 0. The parameter e measures rate constant the sensitivity of money demand to income, while In the IS-LM model, which policy will better the parameter / measures the sensitivity of money stabilize output under the following conditions demand to the interest rate. Explain your answer. d. Solve for r as a function of Y, M, and P and the a. All shocks to the economy arise from exogenous parameters e and f. changes in the demand for goods and services. Using your answer to part (d), determine whether b. All shocks to the economy arise from exog the LM curve is steeper for large or small values of changes in the demand for money. Cancel fand explain the intuition. Op 9. Suppose the demand for real money balances depends f. How does the size of the shift in the LM curve on disposable income. That is, the money demand resulting from a $100 increase in M depend on function is . the value of the parameter e, the income M/P = L(r.Y- T). sensitivity of money demand? Using the IS-LM model, discuss whether this i. the value of the parameter f, the interest sensitivity of money demand? Show All X change in the money demand function alters the following: g. Use your answers to parts (a) and (d) to derive a. The analysis of changes in government purchases an expression for the aggregate demand curve. Your expression should show Y as a function of P. b. The analysis of changes in taxes exogenous policy variables M, G. and T, and the IMG_5652 jpeg 3 pt 10. This problem asks you to analyze the IS-LM model model's parameters. This expression should not contain r. 5 PM algebraically. Suppose consumption is a linear + function of disposable income: h. Use your answer to part (g) to prove that C(Y-T) = a+ KY -T). the aggregate demand curve has a negative slope. IMG_1667.HEIC twoljpg+ 7BE280E-3C47-4 Argument G_6251.jpeg -F3EDG3AF- ReMup_002556 Mapping.ent.dac Screen SAoP02556788/G 1888 HEIC IMG_ 2022-0...32.56 PM IMG_1883.HEIC APR 8 Sm A ? pg.s 2-y