Question 4. (20 points)

Consider an IS-LM model. Suppose the central bank increases the money supply by 5 percent. But the price level also increases increase by 10 percent.

Part a (10 points)

What will be the change in LM curve? What will be the change in equilibrium interest rate and output? Explain properly using a graph?

Part b (10 points)

What will be the change in the AD curve? (Hint: first derive the AD curve from IS-LM model and then consider whether AD will shift to the left or right given the change in LM curve) Given that the SRAS curve is horizontal, what will be the impact of change in AD on price level?