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Suppose that the goods market is given by:
C= c0 + c1 (Y-T)
I = b0 + b1Y -b2i
with 0 < c1 < 1, 0 < b1 < 1, (c1 + b1) < 1, 0 < b2 < 1, and G,T are exogenous constants.
Financial market is given by:
M/P = Y (.25 – i)
a). Derive an equation for equilibrium i in the goods market. Write in words how the interest rate is determined by loanable funds in the goods market.
b). Derive an equation for equilibrium i in the financial market. Describe in words how the interest rate is determined by liquidity preference in the financial market.
c). Describe how it is possible for the interest rate to be determined by the two different relations you derived above: loanable funds in the goods market, and liquidity preference in the financial market.
a)In goods market;sY d =C d + I d +G0Y =c 0+ c 1 (Y −T )+ b 0+b 1 Y −b 2 i Y −c 1Y −b 1 Y =c 0+c 1T +b 0−b 2iY (1−c 1−b 1 )=c 0+c 1T +b 0−b 2 i When more loanable funds are…
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