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Consider the economy of Hicksonia.
a. The consumption function is given by
investment function is
Government purchases 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
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 equilibrium 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 income?
e. Suppose instead that the money supply is increased from 3,000 to 4,500. How
does the LM curve shift? What are the new equilibrium interest rate and
f. With the initial values for monetary and fiscal policy, suppose the price level
rises from 3 to 5. What happens? What are the new equilibrium interest rate
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 parts (d) and (e)?
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