Show the transition dynamics that results an islm space

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Reference no: EM1345761

Lecture Exercise A [IS-LM model with monetary policy] The following equations describe a small economy. Figures are in millions of dollars; interest rate

(i) is in percent per annum. Assume that the price level (P) is fixed.
Goods Market
C = Co + cYD (Private consumption)
YD = Y + TR - T (Disposable income)
T = To + tY (Total taxes)
I = Io - bi (Private investment)
G = Go, TR = TRo (Gov. Expenditure and Transfers, respectively)
Y = C + I + G (Goods mkt. equilibrium condition)
Money Market
L = kY- hi (Demand for real balances)
Ms = Mo/P (Real money supply)
L = Ms (Money mkt. equilibrium condition)
Endogenous Variables: C, YD T, I, Y, L, Ms and i
Exogenous Variables: Co = 300, To = 80, Io = 450, Go = 300, TRo = 100, Mo = 350, P =1
Parameters: c = 0.85, t = 0.15, b = 50, k = 0.25 and h = 62.5
Policy variables: Fiscal policy: (G, t and TR) Monetary policy: (Mo, P)

Questions:

(a) Derive the equations for IS and the LM curves

(b) Determine the equilibrium level of income (Y*) and the rate of interest (i*)

(c) Suppose that the full-employment level of output (YF*) is $3000m. To achieve YF*, the government incurs an additional expenditure of $60m. Using these information:

i. Describe the magnitude of crowding-out that results from the above fiscal expansion

ii. Calculate the accommodative change in money supply that is required to simultaneously eliminate the crowding-out effect as well as to move the economy to full employment level of output

iii. Show the transition dynamics that results in parts (i) and (ii) (above) within an ISLM space

Reference no: EM1345761

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