Suppose that the real demand for money in the economy changes to (M/P)d = 0.2Y - 75r and the real money supply changes to Ms/P = 1,431.9 but the structure of the commodity market is the same as in problem 5.
(a) Derive the equation for the new LM curve and verify that the equilibrium interest rate and real output are the same as you computed in parts 5g and 5h, respectively.
(b) Calculate the slope of the new LM curve, ∆r/∆Y.
(c) Compared to the money demand curve given in problem 5, has money demand become more or less responsive to a change to the interest rate? Is the LM curve steeper or flatter as a result? How does this change in the interest responsiveness of money demand alter the amount by which real output will change following an expansionary change in fiscal or monetary policy?
(d) Compute the new equilibrium interest rate and real output if government spending increases by 160.
(e) Compute the new equilibrium interest rate and real output if G equals 1,700 but the real money supply increases by 100.
(f) How and why do the answers in parts d and e differ from problem 6a and 6b, respectively? Is your prediction in part c confirmed?