Problem 1. According to the IS-LM model, what happens in the short run to the interest rate, income, consumption, and investment under the following circumstances? (Assume everything else is held constant.)
a. The central bank decreases the money supply.
i. The interest rate _______
ii. Income _______
iii. Consumption _____
iv. Investment _______
b. The government decreases its level of expenditures.
i. The interest rate ________
ii. Income _______
iii. Consumption ______
iv. Investment ______
c. The government imposes a new lower level of taxes.
i. The interest rate ______
ii. Income _________
iii. Consumption _______
iv. Investment ___________
d. The government increases government spending while at the same time it increases taxes by exactly the same amount.
i. The interest rate ________
ii. Income ________
iii. Consumption _______
iv. Investment _______
Problem 2. Use the following information to answer this set of questions. An economy can be described by the following equations:
C = 200 + 0.75(Y – T)
I = 200 – 25r
G = 100 and is constant and exogenously determined
T = 100 and is constant and exogenously determined
The demand for real money balances = M/P = Y – 100r
M = money supply = 1000
P = price level = 2
a. Write an equation for the IS curve for this economy.
b. Write an equation for the LM curve for this economy.
c. What is the equilibrium interest rate and the equilibrium level of output for this economy given the above information?
d. What is the equilibrium level of consumption and the equilibrium level of investment for this economy?
e.Suppose that the money supply is increased to 1200. What is the new equilibrium level of interest rate and the new equilibrium level of output for this economy given this change? What is the new equilibrium level of consumption?
f. Suppose that the initial information is true (no change in the money supply). If government purchases increase to 150, what is the change in output predicted by the Keynesian Cross diagram? What is the actual change in output based upon the IS-LM model?