Suppose you are given IS: Y = 1250 - 50r and LM: Y = 450 + 30r , a = 2.5 M = 700 and P = 2, Md = (1/3) Y + 200-10r, Initial equilibrium Y = 750, r = 10 and I = 0 .
a) Evaluate numerically only the impact of fiscal policy on the income level (Y) when government expenditure is increased by $5 billions, under the conditions when:
i) Sensitivity of investment demand to the interest rate is 0.001 and 100.
ii) Sensitivity of money demand to the interest rate 0.001 and 100.
b) Use the above model. How much of investment demand (Id) will be crowded out if the government increases its purchases by 100 (i.e. DG=100). Answer numerically and graphically.
c) Suppose the parameters k (k is the sensitivity of money demand to income) and a are 0.25 and 2.5, respectively. Assume there is an increase of $200 millions in government spending. By how much must the real money balances (PM) be increased to hold interest rates constant?
d) Use the above model. What is the value of equilibrium income and investment when economy is observing liquidity trap situation?