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1. The IS and LM relations, respectively, are:
These equations are in implicit form. In order to use them to solve for equilibrium Y and i, they must first be linearized as follows:
Use the following information to answer the questions below:
a. Derive the IS relation, putting Y on the left and all other terms on the right.
b. Derive the LM relation, putting i on the left and all other terms on the right.
c. Solve for equilibrium real output.
d. Solve for equilibrium interest rate.
e. Solve for equilibrium values of C and I. Verify the value you obtained for Y by adding C+I+G.
f. What happens when money supply increases to 1840? Solve for equilibrium Y and i, I, and C.
a. Illustrate the effect of such a policy mix on output (show both changes on the same graph).
b. Describe in words the effect of the first shift and then of the second. 3. Graphically illustrate and explain what effect a purchase of bonds by the Federal Reserve will have on the money market using the money market graph, and then on equilibrium Y and i, using the IS-LM framework.4. What is the money multiplier and what factors determine its size?5. What is the relationship between the price of bonds and the interest rate? Use a numerical example to assist in your explanation. 6. A fiscal expansion (e.g., a tax cut) will result in an increase in income, an increase in money demand, and an increase in the equilibrium interest rate in financial markets. Explain in words and graphically what happens to the position of the LM curve as policy makers pursue expansionary fiscal policy.
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