Answer to Question #129772 in Macroeconomics for Joseph

Question

Suppose the demand for money is L=0.20Y, the money supply is 200, consumption: C=90+0.80YD, taxes T=50, Investment: I=140-5r, and government purchases: G=50.
i) ii) iii)
Derive the IS and LM equations
Find equilibrium output, and the rate of interest
Estimate the investment level if government spending increases by 20?

Answer 1

i) IS equation

=Y=C+I+G

=90+0.8(Y-50)+140-5r+50

=90+0.8Y-32+140-5r+50

0.2Y=248-5r

Y=1240-25r

LM equation

First equate the Money Supply with Money Demand;

200=0.20 Y

Y=1,000

ii) The equilibrium level of output Y, =1,000

Rate of interest ;1000=1240-25r

-25r=-240

r=9.6%

iii)Increase in Government spending by 20%=1.2$\times$50=60

1000=850+60+I

I=1000-(850+60)

Investment =90