: For an economy the following functions have been given: C = 100 + 0.8Y S = -100 + 0.2Y I = 120 - 5r Ms = 120 Md = 0.2Y - 5r

Find out (1) IS equation,

(2) LM equation,

(3) equilibrium level of income and interest rate.

Solution

IS curve: Y = 1 1 ( ) Y = 1 1 [( + ) )] Where b = MPC, a and Ia are autonomous consumption and autonomous investment respectively, d is sensitivity of investment demand to changes in rate of interest (r).

Substituting these values in IS equation, we have

Y = 1 10.8 [(100 + 120) 5)] = 1 0.2 (220 5) = 5(220 5)

Hence, IS equation: Y = 1100 - 25r

L-M Curve

LM curve: For money market equilibrium;

Md = Ms 0.2Y - 5r = 120

5r = 0.2Y - 120 r = 0.2 5 Y - 24

Hence, LM equation: r = . Y - 24

Equilibrium

Substituting the value of r in the IS equation we have Y = 1100 - 25r Y = 1100 - 25( 0.2 5 Y - 24) Y = 1100 - (1Y - 600) Y = 1100 - Y + 600 88

Y = 1700 Y = 850

2. Consider the following economy: C = 100 + 0.8Yd

I = 50 - 25r G = T = 50

= 200 Md = Y - 25r

1.Calculate the IS and LM curves.

2. Calculate the equilibrium levels of output (national income) and interest.

3. Why do people tend to hold money when the interest rate increases

4. Explain why sometimes LM curves flattens

5. Explain what happens to the LM-IS models when the government expenditure reduces

6. An increase in aggregate demand will have what effect in the LM-IS model explain

7. Suppose the economy is operating in both the LM-IS model what is the justification of this statement

8. How do macroeconomy ensure the economy stability

9. Discuss the effect of inflation in the economy

10.Use your own example show how employment rate is calculated