MGEB06H3 Lecture Notes - Lecture 1: Aggregate Demand, Real Interest Rate

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5 Oct 2015
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MGEB06 – Chapter 9 Tutorial 2
Question 1
Consider an economy that can be described by the following equations:
Consumption: C = 1275 + 0.5(YT) – 200r
Investment: I = 900 – 200r
Real money demand: L(i, Y) = 0.5Y – 200i
Full-employment output: YFE = 4600
Expected inflation: e = 0
Note: both r and i are expressed in decimal points. For example, if r = 0.10, then the real interest
rate is 10%.
a) Derive the IS curve as a function of its exogenous variables.
b) Derive the LM curve as a function of its exogenous variables.
c) Suppose T = G = 450 and MS = 9000. Find an equation that describes the aggregate demand
curve. What are the full-employment equilibrium values of output, consumption, investment,
the real interest rate, and the price level?
d) Suppose that now T = G = 330 and MS = 9000. What is the equation for the aggregate
demand now? Assuming that the economy was initially at the full-employment equilibrium
from part c), what are the new equilibrium values of output, consumption, investment, the
real interest rate, and the price level in the short-run? In the long-run?
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