Sometimes understanding of ISLM becomes clearer when one works through the algebra. This question is designed to promote such understanding. Consider Country A, a closed economy characterized by the following relationships: C = 200 + 0.5YD I = 70- 5r G = T = 100 MD = 500 + Y – 15i where YD, disposable income, is equal to income less taxes, Y-T, and r and i are the real and nominal interest rates expressed in percent. Country A is ruled by a fierce dictator who abhors price movements, so assume prices are not allowed to change in this economy, i.e., that i = r. a) Suppose G rises to 300. Assume no change in taxes or money supply. Derive the new IS curve. Does it shift right? Do rates rise?
Sometimes understanding of ISLM becomes clearer when one works through the algebra. This question is designed to promote such understanding. Consider Country A, a closed economy characterized by the following relationships:
C = 200 + 0.5YD
I = 70- 5r
G = T = 100
MD = 500 + Y – 15i
where YD, disposable income, is equal to income less taxes, Y-T, and r and i are the real and nominal interest rates expressed in percent. Country A is ruled by a fierce dictator who abhors price movements, so assume prices are not allowed to change in this economy, i.e., that i = r.
a) Suppose G rises to 300. Assume no change in taxes or money supply. Derive the new IS curve. Does it shift right? Do rates rise?
b) Suppose the money supply increases from 800 to 950. Derive the new LM curve. Does it shift right? Do rates rise?
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