PART A

Consider a closed economy where the goods and money markets are described by the following relationships:

= 200 + 0.9( )

= 400 15

/ = 200 + 100

= 150

= 100

= 2000

=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.

1. Calculate the equilibrium value of output Y and interest rate r (round off your answers to one decimal point). Compute also the level of consumption and investment spending in equilibrium and check whether the actual level of spending matches the equilibrium level of output.

Suppose that an economist suggests that the equilibrium in the money market should be described by the following equation:

/ = 37.6 + 93

2. With all other behavioural equations as in part (a) (assume that taxation and money supply are at their original level of T = 100 and M = 2000) solve for the equilibrium values of the interest rate and output. Use a graph to show the difference between your result with the one you obtain in question 1) above.