Suppose the IS-LM model is given by the following system of equations:

Y = C + 1 + G

C = 100 + 0.8(Y - T)

l = 280 - 60r

M / P = Y - 200r

Interest rate r is specified in percentage points, so interest rate at 1% means r = 1 , not r = 0.01 Suppose that initially economy is at potential, G = T = 100 M = 1000 P = 1

a. Find the potential level of output and initial equilibrium interest rate r.

b. Now suppose the central bank increases the money supply to M = 1500 Find the new values of Y, r, and P in the short and in the long run. Show both the short and the long- run effect on the IS-LM and AS-AD graphs and explain intuition.

C. Now suppose M = 1000 again, but instead the government increases G to 200. Repeat the exercise in (b) for this situation.

d. Now suppose the central bank fixes the interest rate at the level you found in (a), while the government increases its expenditure to 200 as in (c). Find the new values of Y, M, and P only in the short run. Show on the IS-LM and AS-AD graphs and explain intuition.

e. Now consider what happens in the long run in (d). Is it possible for the government to keep G at the new level and for the central bank to keep r at the old level indefinitely? Explain.

Answer rating: 100% (QA)

Answer Lets solve each part of the question step by step a Initial Equilibrium Given Y C I G C 100 08Y T I 280 60r MP Y 200r Where Y is output C is co... View the full answer