The IS and LM curves for the economy have the following equations:
IS: Y = k(Ap – 200r)
LM: Y = 5(Ms/P) + 500r
where k = 2.5, Aʹp = 5,200, Ms = 1,800, and P = 1.0.
(a) Find the equilibrium level of output and the equilibrium interest rate.
(b) What are the equilibrium real output and equilibrium interest rate when the price level equals 0.8? When it is 1.2? When it is 2.0? Plot the aggregate demand curve based on these answers.
(c) Suppose that natural real output [YN] equals 11,000. Given the aggregate demand curve from part b, determine long-run equilibrium real output, the interest rate, and the price level.
(d) Suppose that autonomous spending increases by 600 billion so that Aʹp = 5,800. What are the equilibrium levels of real output and the interest rate when the price level equals 0.8, 1.0, 1.2, and 2.0? Plot the new aggregate demand curve.
(e) Assume an upward-sloping SAS curve that intersects the original AD curve at Y = 11,000 and P = 1.0. What will happen in the short-run to actual real output, the price level, and the real wage rate as a result of the increase in aggregate demand?
(f) Given the increase in aggregate demand, determine the new long-run equilibrium real output, equilibrium interest rate, and equilibrium price level. Explain what will happen to the nominal wage rate and the SAS curve as the economy adjusts to the new long-run equilibrium.