Reference no: EM131086610
Consider a closed economy, described by the following equations:
(1) C = 0.75YD + 140
(2) YD = Y - T
(3) T = 0.20Y
(4) I = -2,000r + 400
(5) G = G* = constant
(6) Y = C + I + G
(7) MD/P = 2/3Y - 5,000r +750
(8) MS = M* = constant
(9) MS = MD
(10) P = 1
1)Briefly explain equations (1)-(10). Then, derive the equations of the curves (IS) and (LM).
Assume in the following that: G* = 360 and M* = 1500.
2)Compute the equilibrium values of income and of the interest rate. Then, compute the values of all the remaining endogenous variables. Finally, graphically represent the equilibrium using the curves (IS) and (LM).
We assume in the following that equation (4) changes into: (4bis): I = -2,000r +200
3)How can such a change be explained? (suggestion: to answer this question, it may be useful to represent functions (4) and (4bis) on the same chart).
4)Intuitively (i.e. no computation), explain the expected effect of this change in the investment function on the endogenous variables of the model, by building your argumentation on the chart used at question 2-. Then, compute the new values of the endogenous variables of the model, and interpret the results.
Following question 4-: assuming that money supply cannot change, explain what could be the policy of the Government in order to restore the initial equilibrium income (from question 2-). In addition, explain what are the expected consequences on the endogenous variables of the model; you will justify your reasoning using the (IS)-(LM) chart, withoutany computation.
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