The next three questions use the same data: C= 350 + 7Yd; 1= 300 + .3Y - 1500i;

Question

The next three questions use the same data: C= 350 + 7Yd; 1= 300 + .3Y - 1500i; G= 350; T= 300; (M/P)^ d = 35Y - 8500i; M/P = 1950. Using this information derive the IS and LM relations and solve for the equilibrium real output. Solve for the equilibrium interest rate and the equilibrium values of C and I. Then assume M/P rises to 2050 and solve for the new Y and i. If the government simultaneously raises both taxes and expenditures by 125, compute what happens to Y and i. Describe in words what happens to the IS-LM curves? How do you account for the result you obtain?

Explanation / Answer

C = 350 + 0.7Yd; I = 300+ 0.3Y -1500i; G = 250; T = 300 (M/P)d=3.5Y-8500i; M/P=1950 assuming Yd = Y-T

NOW C = 350+0.7(Y-300) = 140 + 0.7Y

Y = C+I+G = 140+0.7Y + 200+.3Y-1500i + 350 = 690+Y-1500i So i=690/1500=0.46

by LM we will get 1950 = 3.5Y-8500*.46 so Y=1674.29

4. i is calculated in previous part C=140+0.7*1674.29=1312

I = Y-C-G=12.29

if M/P is now 2050 i will remain same but Y will change 2050=3.5Y-8500.46 Y=1702.86

5. now G=475 T=425 new C = 350+0.7(Y-425) = 52.5 + 0.7Y

Y = C+I+G = 52.5+0.7Y + 200+.3Y-1500i + 475 = 727.5+Y-1500i So i = 727.5/1500 = 0.485

by LM we will get 1950 = 3.5Y-8500*.485 so Y=1735

We see here that equilibrium value of i and Y both have increased, this can by shift in IS curve, like increase in aggregate demand.

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