Question One [Total 22 marks]

(a) Use a correctly labelled IS-LM graph to show the short run and long run effect on expansionary monetary policy. (10 marks)

Use the following information to answer parts (b) & (c).

Desired consumption is Cd = 300 + 0.5Y - 1500r - 0.5G, and desired investment is I d = 600 - 1500r.

Real money demand is Md/P = Y - 3000i. Other variables are e = 0.1, G = 600, = 1800, and M = 3000.

(b) Find the equilibrium values of the real interest rate, consumption, investment, and the price level. (Assume full employment output level.) (8 marks)

(c) Suppose the money supply increases to 4800. Find the equilibrium values of the real interest rate, consumption, investment, and the price level. (Assume that the expected inflation rate is unchanged and full employment output level.) (4 marks)