Task 3Consider a closed economy where the goods and money markets are described by the following relationships:C = 200 + 0.9(Y – T)I = 400 – 15rM= 200 + Y – 100rPG = 150T = 100M = 2000P = 2Where Cis planned consumption, / is planned investment spending, Tis government tax revenues, G isgovernment purchases, M is the money supply, P is the price level and r is the interest rate.a) Derive the two expressions for the IS and LM equilibrium relationships respectively. Sketch a graph of the tworelationships.b) Calculate the equilibrium value of output Y and interest rate r (round off your answers to one decimal point).Compute also the level of consumption and investment spending in equilibrium and check whether the actuallevel of spending matches the equilibrium level of output.c) The government reduces taxation to T=50 in order to boost economic activity. Assume no changes in thevalues of all the other variables.1.What is the immediate increase in income before the economy adjusts to its new equilibrium?What are the economy's equilibrium level of output Y and interest rate following the cut in taxation?Compute the equilibrium level of consumption and investment spending. With the help of the IS/LMgraph, carefully explain what happens to the economy following the cut in taxation.2.d) If the government intends to pursue monetary policy instead of fiscal policy in order to achieve the same levelof output that you computed in c.2), how much should money supply change by? Use graphs to show thechange in the economy and explain very carefully the monetary transmission mechanism.e) Suppose that an economist suggests that the equilibrium in the money market should be described by thefollowing equation:M= 37.6 + Y – 93rPWith all other behavioural equations as in part (a) (assume that taxation and money supply are at theiroriginal level of T = 100 and M = 2000) solve for the equilibrium values of the interest rate and output.Use a graph to show the difference between your result with the one you obtain in b) above.1.Given the new money market equation, compare the effectiveness of fiscal and monetary policy if, as inc) and d) above, the government reduces taxation to T = 50 or the central bank increases money supplyby the amount you derived in d). Comment on your findings.2.

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Consider a closed economy where the goods and money markets are described by the following relationships: C = 200 + 0.9(Y – T) I = 400 – 15r M = 200 + Y – 100r P G = 150 T = 100 M = 2000 P = 2 Where Cis planned consumption, / is planned investment spending, T is government tax revenues, G is government purchases, M is the money supply, P is the price level and r is the interest rate.

Consider a closed economy where the goods and money markets are described by the following relationships: C = 200 + 0.9(Y – T) I = 400 – 15r M = 200 + Y – 100r P G = 150 T = 100 M = 2000 P = 2 Where Cis planned consumption, / is planned investment spending, T is government tax revenues, G is government purchases, M is the money supply, P is the price level and r is the interest rate.

ECON MICRO

5th Edition

ISBN:9781337000536

Author:William A. McEachern

Publisher:William A. McEachern

Chapter13: Capital, Interest, Entrepreneurship, And Corporate Finance

Section: Chapter Questions

Problem 1.1P

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