Advanced seminar in Economics

Week 11 - IS-LM model

Part a

1. Assume a simple closed economy without government.

(a) Draw an IS curve.

(b) What does this curve represent?

(c) Generally, is it increasing, or decreasing? Why?

(d) How does the interest sensitivity of investment affect the slope of the IS curve?

(e) Under which conditions will the IS curve be vertical? Explain why.

(f) Draw a standard LM curve.

(g) What does this curve represent?

(h) Generally, is it increasing, or decreasing? Why?

(i) How does the interest sensitivity of demand for real balances of money affect the slope of the LM curve?

(j) Under which conditions will the LM curve be vertical? Explain why.

(k) Under which conditions will the LM curve be horizontal? Explain why.

2. Now consider an open economy with government. Suppose it is described by the following equations:

C = 116+0.8(Y −T)−1000r I = 140−2000r,G = 165,T = 30+0.25Y

EX = 100,IM = 110+0.2Y

L = 5Y −100000r M = 60000,P = 100,rrr = 0.2

(a) Find out the equation for the IS and LM curves.

(b) Find out the equilibrium r and Y.

Part b

3. What is a fiscal policy? Describe its tools.

4. What is a monetary policy? Describe its tools.

5. What is crowding out effect? Give all the situations when there won’t be any crowding out effect. Give all the situations when there is a full crowding out effect.

6. Refer to Question 2.

(a) If G increases by 30, then by how much do the IS and LM curves shift and by how much does Y change? How much is the crowding out effect?

(b) If T increases by 30, then by how much do the IS and LM curves shift and by how much does Y change?

(c) If the Fed purchases securities worth of 2500 and there is no leakage of excess reserves, then by how much does it change the money supply? By how much do the IS and LM curves shift and by how much does Y change?