b) If the government intends to pursue monetary policy instead of fiscal policy inorderto achieve the same level of output that you computed in c.2), how much should money supply change by? Use graphs to show the change in the economy and explain very carefully the monetary transmission mechanism. [7 marks] Answer to b) The money supply increases by 100 (2) Suppose that an economist suggests that the equilibrium in the money market should be described by the following equation: 1. Given the new money market equation, compare the effectiveness of fiscal and monetary policy if, as in a) and b) above, the government reduces taxation to T = 50 or the central bank increases money supply by the amount you derived in b). Comment on your findings. [6 marks] Answer : ?? Consider a closed economy where the goods and money markets are described by the following relationships: c = 200 + 0.9(Y T) I=400-15r M F=200+Y100r G=150 T=100 M=2000 P=2 Where C is planned consumption, I is planned investment spending, T is government tax revenues, G is government purchases, M is the money supply, P is the price level and r is the interest rate. a] The government reduces taxation to T=50 ingrderto boost economic activity. Assume no changes in the values of all the other variables. 1. What is the immediate increase in income before the economy adjusts to its new equilibrium? [5 marks] Answer to a 1) increase in come = 450 after tax cut T = 50 2. What are the economy's equilibrium level of output Y and interest rate following the cut in taxation? Compute the equilibrium level of consumption and investment spending. With the help of the IS/LM graph, carefully explain what happens to the economy following the cut in taxation. [8 marks] Answer to a 2b Equilibrium output Y = 3300 r = 25 consumption C =3125 investment I = 25