Chapter 1. Chapter 12 – Problem 4

Step 1

Work It Out
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You must read each slide, and complete any questions on the slide, in sequence.

Question

An economy is initially described by the following equations:

C = 80 + 0.8(Y – T)

I = 120 –5r

M/P = Y – 25r

G = 100

T = 100

M = 2,700

P = 3

Below is the graph of the IS curve and the LM curve. Calculate the equilibrium interest rate and level of income and fill in those values below.

IS: Y = 1100 – 25r

LM: Y = 900 + 25r

The equilibrium interest rate, r, = h4XZagboIgc=%.

The equilibrium level of income, Y, = VjnJvkd43LCDGhCVeIJi3Q==.

Review Chapter 11 pages 314-315, along with Figure 11-7, for a discussion of how to derive the IS curve. Review pages 320-321, along with Figure 11-11, for a discussion of how to derive the LM curve. Review pages 322-324, along with Figure 11-13, for a discussion of how to solve the ISLM model for the equilibrium interest rate and level of income.
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Step 2

Question

An economy is initially described by the following equations:

C = 80 + 0.8(Y – T)

I = 120 –5r

M/P = Y – 25r

G = 100

T = 100

M = 2,700

P = 3

Suppose that a newly elected president cuts taxes by 20 percent. Assuming the money supply is held constant, what are the new equilibrium interest rate and level of income? What is the tax multiplier?

The equilibrium interest rate, r, = OPz0s/Y8/ec=%.

The equilibrium level of income, Y, = 92L3L4iFZh/3Ftx92J51Mw==.

Tax multiplier = BLWB09T71TyDwHBH.

Review Chapter 12 pages 328-331, along with Figure 12-2, for a discussion of how changes in taxes affect the economy in the ISLM model.
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Step 3

Question

An economy is initially described by the following equations:

C = 80 + 0.8(Y – T)

I = 120 –5r

M/P = Y – 25r

G = 100

T = 100

M = 2,700

P = 3

Now assume that the central bank adjusts the money supply to hold the interest rate constant. What is the new level of income? What must the new money supply be? What is the tax multiplier?

The equilibrium level of income, Y, = xY5+LsONVglHPD9FpcjyEg==.

Money supply, M, = qlf9/HNvHEwn/Q/zdrQYYA==.

Tax multiplier = mxfEa2F1skIZd/O4

Review Chapter 12 pages 331-337, along with Figure 12-4, for a discussion of the interaction between monetary and fiscal policy. See also Chapter 12 case study “The U.S. Recession of 2001,” which uses the ISLM model to analyze the fiscal and monetary policy response to that recession.

Question

Now assume that the central bank adjusts the money supply to hold the level of income constant. What is the new equilibrium interest rate? What must the money supply be? What is the tax multiplier?

The equilibrium interest rate, r, = H+eBUSfRCrI=%.

Money supply, M, = KpMQWBR69vAMaHSkA71DKA==.

Tax multiplier = 1Wh3cvJ2xF4=

Review Chapter 12 pages 331-337, along with Figure 12-4, for a discussion of the interaction between monetary and fiscal policy. See also Chapter 12 case study “The U.S. Recession of 2001,” which uses the ISLM model to analyze the fiscal and monetary policy response to that recession.
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