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Consider the following economy: C = .6(Y-T) I = 1,000-20r G = 180 T = 180 MS = 1,500 Md = Y ? 50r...

Question:

Consider the following economy: C = .6(Y-T) I = 1,000-20r G = 180 T = 180 MS = 1,500 Md = Y ? 50r

(a) Calculate the IS and LM curves. Use these curves to determine equilibrium interest rates and output.

(b) Explain in detail the intuition behind why the IS and LM curves are sloped as they are.

(c) Suppose that both G and T rise by 40 to G = T = 220. Calculate what will happen to Y* and i*? Can you explain the intuition behind what is going on here?

Goods and money market (IS-LM model):

Investment-saving function (IS equation) shows all combinations of output Y and interest rate r so that the good market in equilibrium. IS equation is given by: {eq}Y=C+I+G {/eq} in a closed economy, where Y is output, C is consumption, I is investments and G is government spending. Liquidity preference money supply (LM equation) shows all combinations of interest rate r and output Y so that money market is in equilibrium. Money supply Ms equals the money demand Md.

Answer and Explanation:

(a).

{eq}C=0.6(Y-T)\\I=1000-20r\\G=180\\T=180\\Ms=1500\\Md =Y-50r {/eq}

The IS curve is represented by {eq}Y=C+I+G {/eq}

{eq}Y=[0.6(Y-T)]+(1000-2...

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The Money Market: Money Supply and Money Demand Curves

from Economics 102: Macroeconomics

Chapter 11 / Lesson 10
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