Consider the economy of Hicksonia.
a. The consumption function is given by: C = 300 + 0.6(Y – T). The investment function is: I = 700 – 80r. Government purchase and taxes are both 500. For this economy, graph the IS curve for r ranging from 0 to 8.
b. The money demand function in Hicksonia is: (M/P)d = Y – 200r. The money supply M is 3,000 and the price level P is 3. Graph the LM curve for r ranging from 0 to 8.
c. Find the equilibrium interest rate r and the equilibrium level of income Y.
d. Suppose that government purchases are increased from 500 to 700. How does the IS curve shift? What are the new equilibrium interest rate and level of income?
e. Suppose instead that the money supply is increased from 3,000 to 4,500. How does e LM curve shift? What are the new equilibrium interest rate and level of income?
f. With the initial values for monetary and fiscal policy, suppose that the price level rises from 3 to 5. What happens? What are the new equilibrium interest rate and level of income?
g. For the initial value of monetary and fiscal policy, derive and graph an equation for the aggregate demand curve. What happens to this aggregate demand curve if fiscal or monetary policy changes, as in part (d) and (e)?