Discuss what determines the steepness of the lm curve

Assignment Help Macroeconomics

Reference no: EM132945249

Problem 1

Consider the following IS-LM model

C = c₀ + c₁(Y - T)

I = b₀ + b₁Y - b₂i

(M/P)^d = d₁Y -d₂i

(M/P)^s = M/P

where (b₁ + c₁) < 1; G, T and M are constant and given exogenously.

a. Derive the IS relation. What is the slope of the IS curve? Derive dY/dt.

b. Derive the LM relation. What is the slope of the LM curve, i.e., di/dY? The sign of the slope? Discuss what determines the steepness of the LM curve.

c. Now assume that money demand is independent of interest rate, i.e., a vertical LM curve,

(M/P)^d = d_iY

Solve for the equilibrium output and the equilibrium interest rate. How does output change with changes in T?

d. Now assume that money demand is independent of output, i.e., a horizontal LM curve,

(M/P)^d = d₁ - d₂i

Solve for the equilibrium output and the equilibrium interest rate. How does output change with changes in T? Compare your answers to (c) and (d), and explain the difference.

Problem 2

a. Define money multiplier. What is the value of the money multiplier in a system of 100% reserve banking? What is the value of the money multiplier in a system of fractional reserve banking, if all money is held in the form of deposits? Why is the money multiplier higher under fractional reserve banking than under 100% reserve banking? (Word limit: 100 words)

b. Discuss how actions of the public and banks can cause the money multiplier to rise or fall. Does the fact that the public and banks can affect the money multiplier imply that the central bank cannot control the money supply? Why or why not? (Word Limit: 100 words)

Reference no: EM132945249

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