1.

Consider an economy described by the following equations:

Government spending (G)
= 1,000 MUC
Taxes (T)
= 1,000 MUC
Consumption (C)
= 500 + 0.75Yd
Investment demand (I)
= 100 50i
Transaction demand for money (Mt/P) = 0.25Y
Speculative demand for money (Ma/P) = 125 50i
Money supply (Ms/P)
= 500 MUC
The equilibrium level of income in the economy is
(a) 2,000 MUC
(b) 2,750 MUC
(c) 2,450 MUC
(d) 3,000 MUC
(e) 3,500 MUC.
2. The following relationships are given for an economy:
Goods market
equilibrium
Money market
equilibrium
Exports
Import function

0.5Y = 2925
37.5i
0.25Y = 887.5 +
125i
650 MUC
25 + 0.25Y

If the government expenditure increases by 575 MUC, the new

equilibrium rate of interest will be
(a) 12.17%
(b) 10.50% (c) 8.83% (d) 7.30%(e)
6.00%.

1. Answer :

(c)

Reason : Goods market will be in equilibrium when Y = AD = C + I + G

Y = 500 + 0.75(Y T) + 100 50i + 1000
= 1600 + 0.75(Y 1000) 50i
Y = 850 + 0.75Y 50i
0.25Y = 850 50i
Money market will be in equilibrium when:

.. IS curve

Money supply (Ms) = Money demand (Md)

500 = 0.25Y + 125 50i
375 = 0.25Y 50i
0.25Y = 375 + 50i

.. LM curve

Thus, at simultaneous equilibrium,

850 50i = 375 + 50i
475 = 100i
i = 4.75
When i = 4.75, 0.25Y = 375 + 50 (4.75) = 612.5
Or, Y = 612.5/0.25 = 2450.
2. Answer : (e)
Reason : If Government expenditure increase by 575 MUC,
IS function becomes
0.5Y = 2,925 + 575 37.5i
or, 0.5Y = 3,500 37.5i
or, Y = 7,000 75i
At simultaneous equilibrium,
IS = LM
Or, 7,000 75i = 3,550+ 500i
Or, 575i = 3,450
Or, i = 6.00%.