1. FALSE should be: i= 16.2 - 0.

08Y
Assume that the goods market in the economy is in equilibrium, the equation for the IS curve of the economy described below is i= 16.2 - 0.02Y
C̅ = 80 Gbar = 40 Ibar = 40 TRbar= 20 Tbar = 15
mps= 0.60 tax rate =0.5 Interest responsiveness to invest is 10
bar bar bar
Y = C + I – bi +G + c {[(1-t) Y]+TR-T)
Y= Cbar + Ibar – bi +Gbar + cTR-cT + c[(1-t)Y]
Y = 80 +40 + 40 – 10i + 0.4* {[(1-0.5)Y]+20-15)}
Y= 160-10i + 0.2Y + 2
0.8 Y = 162 -10i
10i = 162-0.8Y
i= 16.2 -0.08Y

2. FALSE
Assume that the money market economy is in equilibrium, the equation for the LM curve of the economy described below is: i= -0.25+ 0.05Y
LD = kY-hi Ms = M/P
kY-hi = M/P
0.5Y-20i = 100/10
20i=-10 +0.5Y
i= -0.5+ 0.025Y

3. FALSE
Ignoring the goods market, IF the LM curve is defined by i= -0.25+ 0.05Y is in equilibrium if income is 20
and interest rate is 15.
i=-0.25 +2(0.05) (Y=20) = 1.75

4. TRUE
If the goods and money market described above is in equilibrium, the equilibrium level of output is 159 and
the equilibrium interest rate is 3.5.

iIS= iLM
-0.5 + 0.025 Y = 16.2– 0.8Y
0.105Y=16.7
Y*=159

iIS= iLM
Substitute Y* to: -0.5 + 0.025 Y = 16.2– 0.8Y
-0.5 + (159 *0.025) = 16.1- (0.08*159)
i*= 3.5
 5. FALSE, Excess demand of money (our initital answer is correct, no need for corrections in
your scores)
IF the IS and the LM equation in the above yields Y*= 159 and i*=3.5, there is an excess supply of money if Y= 200 and i=2.
i= -0.5+ 0.025Y
i*= -0.5 + 5 = 3.5, thus the given interest rate is lower compared to the i* in the money market,
opportunity cost of holding money is lower and there’s an incentive to demand more money

3.5

159 200
6. TRUE
IS curve will be flatter if the interest responsiveness of investment demand doubles.
lower slope, flatter
b (in the denominator) increased, thus flatter

From 10i = 162-0.8Y (See underlined equation in # 1)

i= 16.2 -0.08Y to
Now, when interest responsiveness to invest (b=10) doubles
20i = 162-0.8Y
i= 8.1 - 0.04Y (lower slope) ; thus change in b causes
changes in slope
*what other factors cause changes in the slope
of IS in the i and Y space? Multiplier (and those that affect the multiplier such as mpc at tax rate)

7. True
Assume that we are on a liquidity trap, increase in government spending will lead to smaller increase in the equilibrium output the higher the interest
responsiveness to invest (b) is.
Aside from slope, b also affects the magnitude of shift of the IS curve. Higher b, lower shift

, thus, higher b means lower shift in the IS

***If you want to check how autonomous Taxes can affect equillibrium i* and Y* , try setting
C,I,G,TR to zero in this equation:
Y= Cbar + Ibar – bi +Gbar + cTR-cT + c[(1-t)Y]
Then equate it to iLM and compute for Y* and i*.
You may also try to see the individual effect of autonomous consumption, investment,
government spending, and transfers by doing the same.

8. TRUE
If the interest responsiveness of money demand (h) doubles, LM curve will be flatter.
lower slope, flatter
h(in the denominator) increased, thus flatter
From 20i=-10 +0.5Y (See underlined equation in # 3)
i= -0.5+ 0.025Y

Now, when interest responsiveness of

money demand (h =10 ) doubles
40i= -10 + 0.5Y
i = -0.25+ 0.125Y ; thus change in h causes
changes in slope
*what other factors cause changes in the slope
of LM in the i and Y space? Lower k or the income responsiveness of money demand leads to
flatter LM.

9. FALSE
Decrease in inflation will lead to higher equilibrium interest rate and output.

LM shifts to the left

Higher i, lower Y
 10. FALSE
If there is full crowding out and government cut spending by 10 units, both the equilibrium interest rate and
output will increase
IS shifts to the left
Lower i, no change in Y

11. FALSE, no change in i and Y

If the public is prepared to hold whatever amount of money at a given interest rate and the money
circulating in the economy is reduced into half, both equilibrium interest rate and output will increase.

12. TRUE
If the interest rate and output is below the LM curve and above the IS curve there will be an excess demand
of money and excess supply of goods.
To the right of LM, interest rate in the money
market is below equilibrium
To the right of IS, the interest rate in the goods
market is higher than equilibrium