Suppose an economy is characterized by following equations, Consumption: C : 1000 l 0.5(Y T) Investment: I : 500 2007" Government spending: G = 1000 Taxes: T : 1000 Money demand function: (M/P)d : Y 1007' Money supply M = 400, and price level P = 2 1. Derive IS curve, that is use equilibrium condition in goods market write Y as a function of 'r. 2. Derive LM curve, that is use equilibrium condition in money market write Y as a function of r. 3. Find equilibrium (TI, Yf') 4. Draw the IS and LM curves. Label equilibrium (Til/1*) and axes properly Suppose the war is coming, government needs to increase its defensive spending so in crease-m by 50%. Answering following question, government spending 5. What happens to I S curve (state it will shift or not)? Derive new I S curve, and draw it in same graph you did in question 4, label new line as I 82 6. What about LM curve (state it will shift or not)? Derive new LM curve, and draw it in same graph you did in question 4, label new line as LM2 7. Find new equilibrium (r3, Y5\") , and label it in same graph. 8. Circle correct answer for following arguments that explore the impact of increasing in government spending 0 Planed expenditure will (increase / decrease), so rms adjust production and invento ries which has a (positive / negative) effect on output / income a Change in income/ output will be (larger / smaller) than in planned expenditure. 0 Change in income will make people (increase / decrease) demand for real money bal ance, result in (increase / decrease) interests rate r 0 Change in T will (increase / decrease) investment and thus output, though (enough / not enough) to undo initial direction of the change in output. 0 Over all, income/output will (increase / decrease) and interest rate will (increase / decrease) Suppose the war is ended. Central airport were destroyed so government initiate an infrastructure plan to rebuild Central airport. To nance this project, government decide to increase taxes by 50%. 9. What happens to IS curve (state it will shift or not)? Derive new IS curve, and draw it in same graph, label new line as I83 10. What about LM curve (state it will shift or not)? Derive new LM curve, and draw it in same graph, label new line as LM3 11. What are new equilibrium (rg, 1'3\"\"), and label it in same graph. 12. You may notice AT is same as AG. Will this taxes policy make output go back to prewar output level? use marginal propensity of consumption to answer this question. 13. Suppose central bank does not like this taxes policy and want to sustain the output at Y; instead of 173*. What type of monetary policy it should use, expansionary or non expansionary? which means they will increase or decrease money supply ? Which curve will shift? Draw new LM that result from such monetary policy, label this line as LM4