Question

Q3. Suppose that

C = 60 + 0.8YD

I = 150 - 10r

G = 250

T = 200

Ms = 100

Md = 40 + 0.1Y - 10r

( all the magnitudes are in real terms)

a. Write the equations for the IS and LM schedules.

b. Find the equilibrium values for income and the interest rate .

Suppose we change the model such that investment is assumed to be completely

interest inelastic; investment does not depend on the rate of interest and we have

I = 150.

c. Write the new equations for the IS and LM schedules. Show the schedules graphically.

d. Find the new equilibrium values for income and the interest rate. (4+2+8+3=17 marks)

Answer 1

a) $IS:\ I=Y-C-G+T,\ 150-10r=Y-60-0.8Y-250+200$

$Y=1300-50r$

LM:

$Ms=Md$

$100=40+0.1Y-10r$

$Y=600+100r$

b) $1300-50r=600+100r$

$r=4\frac{2}{3}=466.67\%$ - equilibrium; $Y=1066.67$ - equilibrium

c and d) IS:

$150=Y-60-0.8Y-250+200$

$Y=1300$ - equilibrium

LM:

$100=40+0.1Y-10r$

$Y=600+100r$

$1300=600+100r$

$r=7=700\%$ - equilibrium