After reading all the available information carefully, prepare a two page (doubl
ID: 3266765 • Letter: A
Question
After reading all the available information carefully, prepare a two page (double-spaced) essay and answer the following questions:
Assume that we have the following data:
C=100+0.50Y
Ip=100-20r
Mt=0.10Y
Ms=100-10r
M=80
a. Build the IS-LM function.
b. If we assume an increase in Investments by 100 units, please calculate again the IS-LM functions.
c. The intersection of IS-LM functions defines four areas. Please analyze the behavior of the markets for goods and money for each area.
Cite references to material that you use in preparing the essay.
Explanation / Answer
A) we will be using IS Model:
Y = C + I + G + X – M
Y = 100 + 0.5Y + 100 -20r [G = X = M = 0]
(1 – 0.5) Y = 200 – 20r
0. 5Y = 200 – 20r
Y = 400 - 40r (1) [IS Equation]
B) LM Model:
Money demand (Speculative + Transactions demand) = Money supply
100 -10r + 0.1Y = 80
0. 1Y = 10r -20
THE IS-LM FUNCTION 3
Y = 100r – 200 (2) [LM Equation]
When IS- & LM intersect, from section (1):
400 – 40r = 100r – 200
140r = 600
r = 4.29
Y = 100r – 200 = (100 x 4.29) – 200 = 429 – 200 = 229
From the example of the IS curve if the interest rate lowers savings will lower so it will indicate
that the real GDP must elevate so that people can save more money.
C) There are 4 sections of IS-LM functions.
These points are explained as follows:
1) This is when there is an excess supply of goods and money market, which puts pressure downward on interest rates and output.
2) This is when there is an excess demand in the goods market, however, there is an excess supply in the money market, which puts pressure upwards on output and pressure downward on interest rates.
3) This is when there is an excess demand on goods and money market, which puts pressure upwards on interest rates and output.
4) This is when there is an excess supply in the goods market, and excess demand in the money market, which puts pressure downward on output and pressure upward on interest rates.
Conclusion :
The IS curve is used to show the points where the quantity of goods supplied equals those
demanded. The LM curve outlines the equilibrium points for different interest rates, where the
quantity of money demanded equals the quantity of money supplied. These macro economic tools
are used to figure their effectiveness regarding monetary and fiscal policies.