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Extra Question: Question 2 (25 marks) Consider the following closed economy: C4 = 150+ 0.25(YT) 14 = 100 + 0.25Y -1000r M4 7 Y5000(r + 1) Full-employment output Y is 1000, the expected rate of inflation 1 is 0, and the nominal money supply M is 1200. Government purchases are G = 350 and Taxes T = 300. a) Derive the IS curve with the real interest rate r as a function of output Y. (5 marks) S=Y-C*-G = Y-(150+ 0.25(Y T)) 350 =0.75Y 425 (2 marks) sa _ [4 0.75Y 425 =100+0.25Y1000r = _ (IS curve as a function of Y) (3 marks) b) Derive the LM curve with the real interest rate r as a function of output Y and price level P. (5 marks) ma Y5000(r+7); w=0 d = Y5000r; MS = M@ = 1200 at = 5000r p 1200 yy r= 00 (LM curve as a function of Y and P) (5 marks) c) Find the long-run equilibrium values of the real interest rate r, price level P, consumption C, and investment J. (8 marks) _ 525-0.5 525-0.5(1000) _ 0.025 or 2.5% (2 marks) 1000 1000 1200 1200 y- 1000- r=_; 0.025 = __; P = 1.3714 (2 marks) 5000 5000 C = 150 + 0.25( T) = 150 + 0.25(1000-300) = 325 (2 marks) I = 100 + 0.25Y 1000r = 100 + 0.25(1000) 1000(0.025) = 325 (2 marks)