The money and commodity markets are as described in problems 1 and 2 and the real money supply equals $2,750, so that the economy’s equilibrium is initially the same as in part d of problem 2.
(a) During the Congressional election of 2010, Party A proposes to increase government spending on roads and bridges by $120 billion and to pay for that spending by raising taxes by that amount. If Party A’s proposal were to be enacted, derive what the new equations for autonomous planned spending, Ap, and the IS curve, Y = kAp, would be. Graph that new IS curve when the interest rate equals 4.7, 5.0, 5.3, 5.6, and 5.9.
(b) Using your answer to part a, explain at what interest rate and at which level of real income the commodity and money markets would both be in equilibrium under Party A’s proposal.
(c) During the same campaign of 2010, Party B proposes to cut taxes by $80 billion and not change government spending. If Party B’s proposal were to be enacted, derive what the new equations for the autonomous planned spending, Ap, and the IS curve, Y = kAp, would be. Graph that new IS curve when the interest rate equals 4.7, 5.0, 5.3, 5.6, and 5.9.
(d) Using your answer to part c, explain at what interest rate and at which level of real income the commodity and money markets would both be in equilibrium under Party B’s proposal.
(e) Explain how the economy would be similar and different under the proposals of Parties A and B.