Answer 1.
a. To derive the IS curve, we need to solve for Y in the equation Y = C + I + G and substitute the
equations for C and I.
Y=C+I+G
Y = (120 + 0.5(Y - T)) + (100 - 10r) + 50
Y = 270 + 0.5Y - 0.5T - 10r
0.5Y = 220 - 0.5T - 10r
Y = 440 - T - 20r
Now we can graph this equation, where Y is on the vertical axis and r is on the horizontal axis.
b. To derive the LM curve, we need to solve for r in the equation (M/P)d = Y - 20r, and substitute
the given values for M, P, and d.
(M/P)d = Y - 20r
(600/2)d = Y - 20r
300d = Y - 20r
20r = Y - 300d
r = (Y/20) - (15d/2)
Now we can graph this equation, where Y is on the vertical axis and r is on the horizontal axis.
c. The equilibrium level of income and equilibrium interest rate are the intersection of the IS and
LM curves. From the graphs, we can see that the equilibrium level of income is approximately
460, and the equilibrium interest rate is approximately 5%.
b. The equilibrium interest rate is where the money demand and supply curves intersect, which
is approximately 5%.
c. If the supply of money is raised from 1,000 to 1,200, then the Ms curve shifts to the right, and
the new equilibrium interest rate is where the new Ms curve intersects the Md curve. We can
solve for r as follows:
Md = Ms
1,000 - 100r = 1,200/2
1,000 - 100r = 600
100r = 400
r=4
So the equilibrium interest rate decreases from 5% to 4%.
d. To raise the interest rate to 7%, the Fed needs to reduce the money supply until the Md curve
intersects the Ms curve at the new equilibrium interest rate of 7%. We can solve for M as
follows:
Md = Ms
1,000 - 100(7) = M/2
300 = M/2
M = 600
So the Fed should set the money supply to 600 in order to achieve an interest rate of 7%
Answer 3.
Part A:
A recession: Expansionary fiscal policy would be most appropriate in response to a
recession.
A stock market collapse that hurts consumer and business confidence: Expansionary
fiscal policy would be most appropriate in response to a stock market collapse.
Extremely rapid growth of exports: No fiscal policy is required as the economy is already
expanding.
Rising inflation: Tight fiscal policy would be most appropriate in response to rising
inflation.
A rise in the natural rate of unemployment: No fiscal policy is required as this is a
structural issue.
A rise in oil prices: Tight fiscal policy would be most appropriate in response to a rise in
oil prices.
Part B: Let's explain one answer using the AD-AS diagram.
Answer: Expansionary fiscal policy would be most appropriate in response to a
recession.
Explanation: A recession is a period of declining real GDP and increasing
unemployment. In this situation, the aggregate demand (AD) curve shifts leftward, and
the aggregate supply (AS) curve may also shift leftward due to decreased productivity
and investment. Expansionary fiscal policy involves increasing government spending
and/or cutting taxes to increase AD and shift the AD curve to the right.
Graphically, we can illustrate this as follows:
The initial AD and AS curves intersect at point A, representing the equilibrium level of
output Y1 and the equilibrium price level P1. Due to the recession, AD shifts leftward to
AD', causing a decrease in output to Y2 and a decrease in the price level to P2.
Expansionary fiscal policy shifts AD to the right to AD'', causing an increase in output to
Y3 and an increase in the price level to P3. The new equilibrium point represents a
recovery from the recession.
Overall, expansionary fiscal policy is an effective way to boost the economy during a
recession by increasing demand and output.
Midterm Exam
Abdurasul Abdurakhmanov
All Sections
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Dear Students!
Tomorrow, as we agreed, we will have in class Midterm (paper based). Chapters
1,2,3,4,8 and 9 will be covered.