Macroeconomics Project
The following information has been given for a hypothetical economy.
Consumption Function: C=Ca +0.8(Y-T)
Autonomous Consumption: Ca =260-10r
Tax Equation: T = 200 + 0.2Y
Real Demand for Money: (M/P)d = 0.25Y – 25r
Real Money Supply: Ms/P = 2,000
Planned Investment: Ip = 1,900 – 40r
Government Expenditure: G = 1,800
Net Export Equation: NX = 700 – 0.14Y
Answer the following questions based on this information.
(a) Derive the equation for the IS curve.
(b) Derive the equation for the LM curve.
(c) Compute the equilibrium interest rate (r) and real output (Y) for this economy.
(d) Suppose consumer and business confidence decline, resulting in decreases in the amounts of autonomous consumption and planned investment by 40 and 60, respectively. Derive the new equation for the IS curve and compute the new equilibrium interest rate (r) and real output (Y).
(e) Suppose that natural real GDP equals the amount of real output that you computed in part c. Compute the amount of an increase in government expenditure G that would be necessary to overcome the declines in consumer and business confidence and restore real output to natural real GDP.
(f) Suppose that instead of fiscal policy, monetary policy is used to restore real output to natural real GDP. Compute by how much the Fed would have to increase the money supply in order to do so.
(g) Compute the amounts of autonomous consumption and planned investment associated with each of the policies described in parts e and f. Explain which policy is likely to result in a higher rate of growth in real output over the long run.
