ECO202: Homework Assignment 1
1. Read the statements below carefully. Decide whether the underlined statement is true, false or
uncertain and explain the arguments for your answer. If any sentences appear before the
underlined statement, it provides information to you about the scenario – it is true. Answers
without an explanation will not receive credit. If the answer you give is based on any
assumptions, be sure to state them clearly; otherwise, you will not receive full marks.
a. An increase of one unit in government spending leads to an increase of one unit in
b. If both government spending and taxes increase by the same amount, the IS curve does
c. The IS curve is downward sloping because goods market equilibrium implies that an
increase in taxes leads to a lower level of output.
d. All markets are in equilibrium. True, False, or Uncertain: To encourage economic
growth, the Central Bank should engage in a course of monetary policy that will lead to
a decrease in money demand and an increase in bond demand.
e. All markets begin in equilibrium. True, False, or Uncertain: When the Federal
Government works towards reducing the budget deficit, they will also inadvertently
cause investment levels in the economy to decrease.
2. Consider the following closed economy, where Y is tne level of GDP that the government
would like GDP to equal.
C = 100 + 0.75Y d T = 100 Yn= 525
I = 125 – 5i (M/P) = 0.1Y – 2i
G = 100 (M/P) = 60
a. Derive equations for the IS and LM curves. The final equation should have interest rate
as a function of Y (i on the left hand side, Y on the right hand side of the equation).
b. What is the equilibrium level of output and interest rate? Note: the interest rate will
already be expressed as a percent. For example, if i = 1, the interest rate is 1%.
c. Using your answer from above, what type of fiscal policy would move the economy to
Y = 525?
d. Using your answer from above, what type of monetary policy would move the economy
to Y = 525?
3. Suppose the government and Central Bank together want to keep GDP constant, but raise the
level of investment. Using a policy mix, what policies can they follow to achieve this? Using an
IS-LM graph, show the effect before and after the policies. Explain the effect on Y, I, and i.
4. Suppose you’ve been hired by the Government of Canada as an economic consultant to help
make some policy recommendations. You’ve been given the following information about the
domestic closed-economy: the consumption function can be described as 5,0000.5Y D ; the
investment function has been estimated to be 200 Y350i ; government spending is
currently equal to $2,200; lump-sum taxes are currently equal to $2,200; and the estimated
money demand function is 30 Y 2000i . You are also told that the Bank of Canada has
currently set the nominal money stock to be equal to $100,000. The Government of Canada’s goal is to increase GDP to $35,000, but they cannot decide between the two fiscal policy tools
(taxes or government spending). They’ve asked you to accomplish three tasks. Note: interest
rates in this question are quoted as integers, not in decimals (for example: i = 1 means interest
rates are 1%).
a. If they decided to change taxes (while keeping government spending the same),
determine what the new lump-sum tax amount should be set equal to in order to achieve
their previously stated goal.
b. If they decided to alter levels of government spending to raise GDP (while keeping
taxes the same), determine what the new level of government spending should be.
c. If the change to taxes (ΔT) and change in government spending (ΔG) for the first two
tasks are different, please explain why.
5. Assume that the closed-econ