Question 1 Use the IS-LM model to analyze the effects of 1. a housing market crash that reduces consumers wealth 2. consumers using cash in transactions more frequently in response to an increase in identity theft For each shock, 1. use the IS-LM diagram to determine the effects on Y and r. 2. figure out what happens to C, I, and the unemployment rate. Question 2 This problem asks you to analyze the IS-LM model algebraically. Suppose consumption is a liner function of disposable income: C(Y-T) = a + b(Y-T) Where a>0 and 00 and d>0. The parameter d measures the sensitivity of investment to the interest rate, and the parameter c is a constant sometimes called autonomous investment. a. Solve for Y as a function of r, the exogenous variables G and T, and the models parameters a, b, c, and d.

3 b. How does the slope of the IS curve depend on the parameter d, the interest sensitivity of investment? Refer to your answer in part (a) and explain your intuition. c. Which will cause a bigger horizontal shift in the IS curve, a $100 tax cut or a $100 increase in government spending? Explain the intuition. Now suppose demand for real money balances is a linear function of income and the interest rate: L(r,Y) = eY fr, Where e>0 and f>0. The parameter e measures the sensitivity of money demand to income, while the parameter f measures the sensitivity of money demand to the interest rate. d. Solve for r as a function of Y, M, and P and parameters e and f. e. Using your answer to part (d), determine whether the LM curve is steeper for large or small values of f, and explain the intuition. f. How does the size of the shift in the LM curve resulting from a $100 increase in M depend on e and f? g. Derive an expression for the aggregate demand curve. (Hint: your expression should show Y as a function of P; of exogenous policy variables M, G, T; and of the models parameters. Definitely should not contain r) h. Prove aggregate demand curve has a negative slope. Question 3 Monetary policy and fiscal policy often change at the same time. a. Suppose the government wants to raise investment but keep output constant. In the IS-LM model, what mix of monetary and fiscal policy will achieve this goal? b. In the early 1980s, the U.S. government cut taxes and ran a budget deficit while the Fed pursued a tight monetary policy. What effect should this policy mix have? only this

17:06 - 04% 10% 1 homework March podcep te Buchen und durch ded __ and r care 1. mart that made with owhuhul, and the way Missindia. The parEK yarrary Nagy Au t hor LMC de il 199 USD 17:06 - 04% 10% 1 homework March podcep te Buchen und durch ded __ and r care 1. mart that made with owhuhul, and the way Missindia. The parEK yarrary Nagy Au t hor LMC de il 199 USD