Reference no: EM13191991

Suppose that the following equations describe an economy (C, I, G, T, and Y are measured in billions of dollars and r is measured in percent, not in decimals)
C=170+0.6(Y-T)
T=200
I=100-4r
G=350
(M/P)^d=L=0.75y-6r
M^s/P=M/P=735

a. Derive the equation for the IS curve (Hint: It is easier to solve for real output Y here)

b. Derive the equation for the LM curve (Hint: Again, it is easier to solve for real output Y here)

c. Now express both the IS and LM equations in terms of r. Draw both curves and calculate their slopes.

d. Use the equations from Parts a and b to calculate the equilibrium levels of real output Y, the interest rate r, planned investment I, and consumption C.

e. At the equilibrium level of real output Y, calculate the value of the government budget surplus.

f. Suppose that G increases by 36 to 386. Derive the new IS and LM equations and draw these curves on the graph you drew for Part c.

g. Refer to the IS and LM equations you derived in Part f. With Y on the left-hand side of the equations, calculate the new equilibrium levels of real output Y, the interest rate r, planned investment I, and consumption C.

h. Instead of increasing G, suppose that the Fed sought to achieve the equilibrium level of real output Y in Part g through expansionary monetary policy alone. By how much would the Fed have to increase the money supply? (Hint: Start by drawing the appropriate shifts in the IS curve and/or the LM curve in Parts f and h.)

i. Compare the equilibrium levels of consumption C, government spending G, and planned investment I in Parts g and h. Based on this comparison, why might some economists prefer expansionary fiscal policy while others prefer expansionary monetary policy?