Florida Atlantic University ECO 3203 Chapter 11 1)In the Keynesian cross model, assume that the consumption function is given by C = 120 + 0

Florida Atlantic University

ECO 3203

Chapter 11

1)In the Keynesian cross model, assume that the consumption function is given by C = 120 + 0.8 (Y-T). Planned investment is 200; government purchases and taxes are both 400.

a.            C= 120 + 0.8 (Y-T)

b.            Y = 400 +0.8Y 0.2Y = 400

3. Change in Income = change in government spending x government spending multiplier

4. Required change in Income = required change in government spending x government spending multiplier

2400 - 2000 = required change in government spending x 1 / 1-MPC 400 = required change in government spending x 1 / 1 - 0.8

400 = required change in government spending x 1 / 0.2 Required change in government spending =

5. Required change in Income = required change in tax x tax multiplier 2400 - 2000 = required change in tax x -MPC / 1 - MPC

400. required change in tax x -0.8 / 1 - 0.8 400 = required change in tax x (-4) Required change in tax =

a.  m/p = 800 ^^

2. We get the equilibrium interest at the point of intersection between the demand for money and real balances of money.

400 = 800 – 50r

400 = 50r

r = 400/50 = 8

Therefore so the equilibrium interest rate 8%

3. If the supply of money is reduced from 2,000 to 1,500 then the new supply of real money balances will equal (M/P)^s= 300

300 = 500 – 5r

500 = 50r

r = 500/50 = 10

When the money supply is reduced from 2000 to 1500 the equilibrium interest rate increases from 8% to 10%.

4. If the central bank set the interest rate at 4% then (M/P)^S=(M/P)^D then:

M/P = 800 – 50r

In this model the price level is fixed at 5 therefore:

M/5 = 800 – 50(4)

M/5 = 800 – 200

M/5 = 600

M = 600 * 5

Therefore if the central bank wants the interest rate to be 4% the money supply should be set at 3,000.

3. The following equation Describes an Economy

1. 1. Y = output of the economy

1. 2. To derive the IS curve, we use the equation:

Y = C + I + G

= 50 + 0.75(Y-200) + 150 – 10r +250

1. 3. To derive the LM curve we first find supply of real money:

Then we assume equilibrium between money demanded and money supplied:

1. 4. To find the equilibrium level of income and equilibrium interest rate we set the LM curve to the IS curve to equal each other, to find r and Y:

1)Consider the Economy Hicksonia

1. The IS curve equation is:

Y = C + I + G

2. The LM curve equation is derived by:

3. We can attain equilibrium by setting IS = LM

4. If G increases from 500 to 700 (on the IS curve)

5. If M increases from 3,000 to 4,500 (on the lm curve):

6. If the price level rises from 3 to 5 then:

7. To calculate aggregate demand curve: