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Problem Set 1 - 2014

The document is a problem set for a Macroeconomics-II course, focusing on the derivation and interpretation of the IS and LM curves in the goods and money markets. It includes tasks such as graphing these curves, analyzing the effects of government spending on equilibrium, and deriving the aggregate demand equation. The problem set requires mathematical proofs and economic interpretations of various relationships within the macroeconomic framework.

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17 views2 pages

Problem Set 1 - 2014

The document is a problem set for a Macroeconomics-II course, focusing on the derivation and interpretation of the IS and LM curves in the goods and money markets. It includes tasks such as graphing these curves, analyzing the effects of government spending on equilibrium, and deriving the aggregate demand equation. The problem set requires mathematical proofs and economic interpretations of various relationships within the macroeconomic framework.

Uploaded by

pranjalichhajed233
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Macroeconomics-II

Problem Set 1

Date: 10th January 2024- 1st February 2024 Point: 60 (15%)

Please clearly derive all the steps and explain the economic interpretation of the equations
and graphs.

Q 1:
Goods market
𝑪 = 𝒄𝟎 + 𝒄𝟏 (𝟏 − 𝒕)𝒀, where C is consumption; Y is income; t represents a proportional tax;
and 𝒄𝟎 and 𝒄𝟏 are positive constants.
𝐈 = 𝒃𝟎 − 𝒃𝒊 𝒊, where I is investment; i is the interest rate; and 𝒃𝟎 and 𝒃𝟏 are positive constants,
G = Government expenditure, and it is a positive constant.
Money market
𝑴𝒅 = 𝑷(𝒎𝟎 + 𝒎𝟏 𝒀 − 𝒎𝟐 𝒊), where 𝑴𝒅 is money demand; P is the price level; 𝒎𝟎 (a positive
constant) represents exogenous changes to 𝑴𝒅 ; and 𝒎𝟏 and 𝒎𝟐 are also positive constants. Let
𝑴𝒔 represent money supply,

A) Derive the IS curve and give the definition of the IS relation. Prove that IS curve is

(Hint: combine the goods market equations to derive an expression for Y as a function of i) [
10 Points]

B) Derive the LM curve and give intuition for why the LM curve slopes upward/downward.
Prove that LM curve is

(Hint: Use the money market equations to express i as a function of Y) [ 10 Points]

1
C) Graph the IS and the LM curves on the same diagram, putting i on the vertical axis and
labeling the curves. Label the equilibrium interest rate and output, i0 and Y0, respectively. [ 5
Points]

D) Suppose the government increases its spending by ΔG (Using multiplier effect). Which
curve will shift, if any? Calculate by how much it will shift and draw a diagram that shows the
impact of this policy [5 points]

E) Derive the expression for aggregate demand using IS and LM equations. Is the AD curve
upward- or downward-sloping? Prove that AD curve is; [ 10 Points]

𝟏
(Hint- 𝝀 = for simplicity. To derive the AD curve, you can substitute in for i into
𝟏−𝒄𝟏 (𝟏−𝒕)

the IS equation from the LM equation]

F) Show (mathematically) that output, Y, is an increasing function of the real money stock,
M/P, and an increasing function of government spending, G. [10 Points]

𝟏𝟎𝟎
G) Prove that Aggregate Demand AD, 𝒀 = 𝟒𝟎𝟎 + using below figures [ 10 Points]
𝑷
S
Let: c0 = 200, c1 = 0.5, b0 = 300, b1 = 0.4, m0 = 400, m1 = 1, m2 = 0.8, M = 200, G =100,
Yn=550, t=0

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