|Question||A Pigou Effect is introduced into an economy similar to problem 3 by allowing A?p to become price-dependent. We now have:
IS: Y = k(A?p – 200r)
LM: Y = 5(Ms/P) + 500r
where k = 2.5, A?p = 4,600 + 600/P, Ms = 1,800, and P = 1.0. As with parts a and b of problem 3, this problem aims to derive the AD curve.
(a) Find the equilibrium level of output and the equilibrium interest rate.
(b) What are the equilibrium real output and equilibrium interest rate when the price level equals 0.8? When it is 1.2? When it is 2.0? Plot the aggregate demand curve based on these answers.
(c) Is the AD curve flatter or steeper than the AD curve of part b of problem 3?