Consider first the goods market model with constant investment that we saw in Chapter 3. Consumption is given by:

C = Co + c1(Y-T)

And I, G and T are given.

a. Solve for equilibrium output. What is the value of the multiplier?

Now let investment depend on both sales and the interest rate:

I = b0 + b1Y -b2i

b. Solve for equilibrium output using the methods learned in chapter 3. At a given interest rate, why is the effect of a change in autonomous spending bigger than what it was in part (a)? Why? (Assume c1 + b1 = 1)

13

MAE206D /April 2020

c. Solve for equilibrium level of investment.

d. Let's go behind the scene in the monetary market. Use the equilibrium in the money market M/P = d1Y - d2i to solve for the equilibrium level of the real money supply.

How does the real money supply vary with government spending?