Question
The following equations describe the economy in Country A in 2020. ConsumptionC = 1000 + 0.6Yd - 400r InvestmentI = 250 - 500r Government spendingG
The following equations describe the economy in Country A in 2020.
ConsumptionC = 1000 + 0.6Yd - 400r
InvestmentI = 250 - 500r
Government spendingG = 500
ExportsX = 1500
ImportsM = 500 + 0.4Y
Income tax ratet = 0.2
Money demandMd = 1000 - 250i
Money supplyMs = 985
Expected inflation ratee = 0.05
where Yd is disposable income, i is nominal interest rate, and r is the real interest rate.
a. What is the equilibrium nominal interest rate in Country A in 2020? Explain your calculations.
b. What is the equilibrium real interest rate in Country A in 2020? Explain your calculations.
c. What is the equilibrium output in Country A in 2020? Explain your calculations.
d. The final term in the equation describing investment, 500r, implies that a 1 percent (0.01) increase in the real interest rate reduces investment spending by 500(0.01) = 5 units. Similarly, the final term in the equation describing consumption, 400r, implies that a 1 percent (0.01) increase in the real interest rate reduces consumption spending by 400(0.01) = 4 units.
Briefly explain how the effectiveness of a monetary policy depends on the responsiveness of planned investment towards changes in real interest rate as well as on the responsiveness of consumption spending towards changes in real interest rate.
State the number of words used at the end of your answer.
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