Reference no: EM132177140

Consider the following economy:

C=1500+0.5(Y-T)-200r

I=900-300r

L=Y-250r

Expected inflation = 0.

Government Budget = T-G.

Assume the economy is initially below full potential.

a. What is mpc equal to?

b. Suppose that T=G=200, Ms=5000 and P=2. Solve for the IS curve, LM curve and the equilibrium values of r and Y. Then solve for equilibrium C, I, and the Government Budget.

c. Now suppose that T=200 (still) and G=825, Ms=5000 and P=2. Solve for the IS curve, LM curve and the equilibrium values of r and Y. Then solve for equilibrium C, I, and the Government Budget. By how much did Y and r change?

d. Continue with part c. Given that G increased from 200 to 825, by how much will Y increase in the Goods and service Market only? Calculate it. How does your result compare to the change in Y you reported in part c? Why are these different?

e. Illustrate the impact of the change in the policy (from c) on the IS-LM diagram.  (Label all axes, curves, and changes that you show --- you need to clearly illustrate the change in r and Y, and the old vs. new equilibrium).

f. Now discuss intuitively the impact of the rise in G on the economy. I.e. provide a verbal analysis of the impact of a rise in G. Provide complete intuition as we did in class, making sure to discuss the impact on the economy, including the impact on output, consumption, investment, interest rates, money demand, production.

g. Lastly, if the full-employment level of output (Y) = 3250, did the higher G bring the economy back to full-employment? Discuss.