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The following equations describe an economy.
Y=C+I+G
C=50+0.75(Y-T)
I=150-10r,
(M/P)d=Y-50r,
G=250,
T=200
M=3000,
P=4
a. Identify each of the variables and briefly explain their meaning.(5 Marks)
Meaning of the variables
Y = gives the value of all goods and services produced in an economy which is also referred
to as the Gross Domestic product (GDP).
C = represents the consumption function. Consumption is a function of disposable income
which is obtained by subtracting tax from income level (Y-T).
I = is the investment function. It is a function of interest rate. Investments are negatively
related to interest rate. An increase in interest rates makes borrowing expensive and
thereby slows down investment.
G = is the government expenditure or the government spending.
(M/P)d = is the money demand. It's a function of interest rates.
Ms = is the money supply
P = is the price level.
b. From the above list, use the relevant set of equations to derive the IS curve. Graph the IS curve
on an appropriately labeled graph.(5 Marks)
IS curve
The IS curve represents the product market. It given by the equation;
Y=C+I+G
Y=50+0.7(Y-T) + 150-10r + 250
But T=200
Y=50+0.7(Y-200) + 150-10r + 250
Y=50+0.7Y-140 + 150-10r + 250
0.3Y=310-10r
Y=1033.33 - 33.33r
IS curve: Y=1033.33 - 33.33r
This study source was downloaded by 100000813451415 from CourseHero.com on 06-28-2022 06:01:42 GMT -05:00
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c. From the above list, use the relevant set of equations to derive the LM curve. Graph the LM curve
on the same graph you used in part (b).(5 Marks)
LM curve
(M/P)d=Y-50r
Ms=3000
P=4
(M/P)d=(M/P)s=M/P
3000/4= Y-50r
750= Y-50r
Y=750+50r
LM curve: Y=750+50r
d. What are the equilibrium level of income and the equilibrium interest rate? For any (5 Marks)
Equilibrium level of income and interest rate
IS curve: Y=1033.33 - 33.33r
LM curve: Y=750+50r
Equating the two equations;
1033.33 - 33.33r =750+50r
83.33r=283.33
r=3.4
Y=750+50*3.4=920
This study source was downloaded by 100000813451415 from CourseHero.com on 06-28-2022 06:01:42 GMT -05:00
https://www.coursehero.com/file/90126746/The-following-equations-describe-an-economydocx/
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