Consider the following numerical example of the IS-LM model:
C = 200 + 0.25YD
I = 150 + 0.25Y - 1000i
G = 250
T = 200
i = 0.05 (the i has a bar over it)
a. Derive the IS relation. (Hint: You want an equation with Y on the left side and everything else on the right.)
b. The central bank sets an interest rate of 5%. How is that decision represented in the equations?
c. What is the level of real money supply when the interest rate is 5%? Use the expression (M/P) = 2Y - 8000i
d. Solve for the equilibrium values of C and I, and verify the value you obtained for Y by adding C, I, and G.
e. Now suppose that the central bank cuts the interest rate to 3%. How does this change the LM curve? Solve for Y, I, and C, and describe in words the effects of an expansionary monetary policy. What is the new equilibrium value of M/P supply?
f. Return to the initial situartion in which the interest rate set by the central bank is 5%. Now suppose that government spending increases to G = 400. Summarize the effects of an expansionary fiscal policy on Y,I, and C. What is the effect of the expansionary fiscal policy on the real money supply?