The following equations describe an economy:

Consumption : C= 30+0.9YD - i

Investment : I= 500 - 13i

Government Spending : G=200

Transfer Payments: TR=200

Taxes: TA= 0.2Y

LM Curve : Y= 2,500+ 100i

Real Money Demand : L=kY- hi

Money Suppy : MS= 1,500

Price Level : P=2

where Y is income, i is the percentage of interest rate, YD is the disposal income, and k and h

are positive parameters that govern the real money demand. Notice that consumption is

postulated to be negatively related to the interest rate.

(a) What are the values of (i) marginal propensity to consume out of disposal

income and (ii) marginal propensity to consume out of total income?

(b) Derive the IS equation for the economy.

(c) Find the values of (i) k and (ii) h that are consistent with the money market

equilibrium.

(d) Solve for the equilibrium levels of (i) output, (ii) interest rate, (iii) consumption,

(iv) investment and (v) government budget surplus.

(e) Derive the aggregate demand (AD) curve for the economy.

(f) Suppose the transfer payments (TR) are increased by 140. Determine the size of the horizontal shift of the IS curve; that is, how much can output increase by if the interest rate is maintained at the same level as in part (d).

(g) Determine the change in the equilibrium output, while taking into account the

equilibrium change in the interest rate.

(h) Based on your answers to parts (f) and (g), how much is the crowding-out effect

of an increase in the transfer payments on output? Show your work. Note: start your answer

by defining in words what is presisely meant by the crowding-out effect of an expansionary

fiscal policy.

(i) Under the same price level P = 2, if the Federal Reserve System intends to

eliminate the above crowding-out effect completely, how much should the nominal money

supply (Ms) increase by?