This question asks you to analyze the IS-LM model algebraically. Suppose consumption is a linear… Show more This question asks you to analyze the IS-LM model algebraically. Suppose consumption is a linear function of disposable income: C(Y %u2212 T) = a + b(Y %u2212 T), where a>0 and 0**0 and d>0. %u20AC What is the equilibrium level of income? If government purchases increases to 125, what is the new equilibrium income? What level of government purchases is needed to achieve an income of 1600? Solve for Y as function of r, G, T and model parameters a, b, c, and d . How does the slope of the IS curve depend on the parameter d, the interest rate sensitivity of investment (Hint: use the equation from part a) What will cause a bigger horizontal shift in the IS curve, a $100 tax cut or a $100 increase in government spending? Refer your answer to part (a). Now suppose demand for real money balances is a linear function of income and interest rate: L(Y,r) = eY %u2212 fr d. Solve for r as a function of Y, M, P and parameters e and f. where e>0 and f>0. %u20AC e. Using your answer to part (d), determine whether the LM curve is steeper for large or small values of f. (Hint: as slope of LM increases curve becomes steeper) • Show less
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