Question

Suppose the central bank's monetary policy sets the interest rate according to the function:
i = 2 + 2(π - π*) with π* = 2,
and aggregate expenditure is:
AE = 140 + 0.2Y - 10i

a) What is the equation for the ADπ curve? Use 'PI' to represent π when entering your equation.

b) Plot the ADπ curve in the graph below.

Answer 1

a)$AD=AE$

$i = 2 + 2(π - π*)$

with π* = 2

$i = 2 + 2(π -2)=2+2π-4=2π-2$

$AE = 140 + 0.2Y - 10i$

$i =2π-2$

$AE = 140 + 0.2Y - 10i=140+0.2Y-10(2π-2)=140+0.2Y-20π+20=160+0.2Y-20π$

$PI=π$

$AD=AE=Y$

$AD =160+0.2Y-20π$

$Y =160+0.2Y-20PI$

$Y=\frac{160-20PI}{0.8}$

$AD=\frac{160-20PI}{0.8}$

b)