Q1

Consider the following model: C = 10 + 0.8YD, I = 0.1Y 20i, G = 20, and T = 25 1. Find the equation of the IS curve and plot it with Y on x axis and i on y axis. 2. What are the numerical values of the y intercept and slope of the IS curve in your graph? 3. Combine the IS equation with the investment function above to find an expression for investment (I) as a function of output (Y )? 4. Find the saving function S(Y ). Compare the saving function S(Y ) with the investment function I(Y ) and explain. 5. Assume that the interest rate is 10%, i.e. i = 0.1. Find the numerical values of the following variables in equilibrium: Y , C, I and S. Verify that your results satisfy the two versions of the goods-market equilibrium condition

Q2

In an open economy that is on a fixed exchange rate, show the short run effects on output and interest rate of a decrease in consumer confidence. To answer this question, draw the following four diagrams: 1. The goods market, 2. The money market, 3. The IS-LM curves, and 4. The interest parity condition. Clearly label the initial and new equilibrium points in each diagram. Provide brief explanations for the changes.