Answer to Question #63293 in Macroeconomics for Sharon

Question

You are given the following information of commodity market and money market of a closed economy without government intervention.

The commodity market consumption function ​C = 50 + 2Y

​5

Investment function​ I = 790-21r

Money Market:

Precautionary and Transaction demand for money.

MDT =​ 1Y

​6​

Speculative demand

MDS= 1200-16r

Money supply

MS= 1250

1. Determine the;
i) Equilibrium level of income.
ii) Interest rate for this economy.
2. Using a well labeled diagram, Illustrate the equilibrium condition in part i) above.

Answer 1

C = 50 + 2/5Y, I = 790 – 21r
MDT = 1/6 Y, MDS = 1200 -18r, MS = 1250
In equilibrium Y = C + I and MD = MDT + MD­S = MS, so:
50 + 2/5Y = 790 – 21r
1/6 Y + 1200 - 18r = 1250,
2/5Y + 21r = 740
1/6Y - 18r = 50 -> 2/5Y - 43.2r = 120, so if we subtract second equation from the first, we will get:
64.2r = 620
r = 9.66%
Y = (740 - 21*9.66)/0.4 = $1343
So, r = 9.66% and Y = $1343 are the equilibrium levels of income and interest rate for this economy.