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Derive the is relation

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Suppose that the economy is characterized by the following behavioural equations: C = 800 + 0.8 Yd I = 150 + 0.1 Y -1000 i G = 210 T = 200 + 0.5Y (M/P)d = 100+ 0.5Y - 500 i

The central bank sets the interest rate, i = i0 = 0.1

a) Derive the IS relation, and draw it in {i, Y} space. (Hint: solve for an equation with i on the left hand side)

b) Derive the LM relation, and draw it in {i, Y} space. (Hint: solve for an equation with i on the left hand side)

c) Solve for equilibrium real output Y, consumption C and investment I.

d) Solve for the equilibrium real money supply. (2 marks) Suppose that the central bank lowers the interest rate to 0.

e) What will be the percentage effect on output? Illustrate your answer with an IS-LM graph and explain. Now suppose the government raises government expenditure to 300 (with the interest still set at 0).

f) What is the percentage effect on output relative to its value in part e)? Illustrate your answer with an IS-LM graph and explain.

Reference no: EM132631757

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