Assume That in a Certain Economy the LM Curve Is

question 52

Essay

Assume that in a certain economy the LM curve is given by Y = 2,000r - 2,000 + 2(M/P)+ u,where u is a shock that is equal to +200 half the time and -200 half the time,and the IS curve is given by Y = 8,000 - 2,000r.The price level (P)is fixed at 1.0.The natural rate of output is 4,000.The government wants to keep output as close as possible to 4,000 and does not care about anything else.Consider the following two policy rules:
i.Set the money supply M equal to 1,000 and keep it there.ii.Manipulate M from day to day to keep the interest rate constant at 2 percent.a.Under rule i,what will Y be when u = +200? Under rule i,what will Y be when u = -200?
b.Under rule ii,what will Y be when u = +200? Under rule ii,what will Y be when u = -200?
c.Which rule will keep output closer to 4,000?

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Definitions:

Percentage

A percentage is a mathematical term that describes a number expressed as a fraction of 100, used to denote a portion of a total.

Compound Interest

The interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan.

Exponential Growth

A growth pattern characterized by the rate of increase becoming quicker relative to the growing total number or size.

Financial Calculation

The process of determining financial figures, often involving interest, cash flows, investments, margins, and returns analysis.