Homework 3 (suggested solution) Due date: Dec 15 1. Suppose that the following equations describe an economy (C, I, G, T, and Y are measured in billions of dollars and r is measured in percent; for example, r = 10 means r = 10 percent): C = 170 + 0.6(Y - T) T = 200 I = 100 - 4r G = 350 (M/P)d = L = 0.75Y − 6r Ms/P = M/P = 735. a. Graph the IS and LM curve and show me the slopes and intercepts. slope of IS curve 1/10; slope of LM curve 1/8 b. Calculate the equilibrium levels of real output Y, the interest rate r, planned investment I, and consumption C. r 15 (percent); Y 1,100; I 40; C 710 c. At the equilibrium level of real output Y, calculate the value of the government budget surplus. 150 d. Suppose that G increases by 36 to 386. Derive the new IS and LM equations and plot and draw these curves on the graph you drew for Part a. The LM equation remains unchanged. The new IS equation is Y 1,340 10r. e. What is the horizontal shift in the IS curve and/or the LM curve in Part d (i.e., if r remains constant, by how much does Y increase on each curve)? The shift in the IS curve is equal to 90. The LM curve does not shift. f. Refer to the IS and LM equations you derived in Part d. With Y on the left-hand side of the equations, calculate the new equilibrium levels of real output Y, the interest rate r, planned investment I, and consumption C. Y 1,140; r 20; I 20; C 734 g. Instead of increasing G, suppose that the Fed sought to achieve the equilibrium level of real output Y in Part h through expansionary monetary policy alone. By how much would the Fed have to increase the money supply? 54 h....
