Assume That an Economy Is Described by the IS Curve

question 18

Essay

Assume that an economy is described by the IS curve Y = 3,600 + 3G - 2T - 150r and the LM curve Y =
2M/P + 100r [or r = 0.01Y - 0.02(M/P)]. The investment function for this economy is 1,000 - 50r. The consumption function is C = 200 + (2/3)(Y - T). Long-run equilibrium output for this economy is 4,000. The price level is 1.0 and M = 1,200.
a.Assume that government spending is fixed at 1,200. The government wants to achieve a level of investment equal to 900 and also achieve Y = 4,000. What level of r is needed for I = 900? What levels of T and M must be set to achieve the two goals? What will be the levels of private saving, public saving, and national saving? (Hint: Check C + I + G = Y.)
b.Now assume that the government wants to cut taxes to 1,000. With G set at
1,200, what will the interest rate be at Y = 4,000? What must be the value of M? What will I be? What will be the levels of private, public, and national saving? (Hint: Check C + I + G = Y.)
c.Which set of policies may be referred to as tight fiscal, loose money? Which set of policies may be referred to as loose fiscal, tight money? Which "policy mix" most encourages investment?

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Definitions:

Causal Link

The connection or relationship between two events where one is understood to be a consequence of the other.

Occurs

Happens or takes place.

Cause

A factor or element that brings about an effect or result.

Hasty Generalization

A logical fallacy where a conclusion is not logically justified by sufficient or unbiased evidence.