Consider the following IS/LM model of a closed economy; The interest rate (r) an

Question

Consider the following IS/LM model of a closed economy;

The interest rate (r) and real income (Y) are endogenously determined variables in this economy. We
continue to ignore the FE line and so treat the price level (.P) as exogenously determined and fixed.

(d) Define the government budget deficit (D) as the difference between government expenditure and tax
revenue. Thus D = G - T, or using equation (3) to substitute for T we find;

(10) D = G-0.25Y

What is the size of the government budget deficit in the equilibrium you defined in part (b )?

Explanation / Answer

Y = C + I + G

or, Y = 100 + 0.6Y - 0.15Y + 100 - 55r + 240

or, Y = 800 - 100r ............IS

(M/P)d = (M/P)s

or, 500 + 0.2Y - 25r = 520

or, Y = 100 + 125r ...............LM

At equilibrium,

IS = LM

800 - 100r = 100 + 125r

or, r = 3.11%

Y = 489

D = 240 - (0.25*489) = 117.75

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.