19. Answer all parts (a)-(e) of this question An economy with fixed prices and unemployed labour has the following relationships: Consumption: C = 140+ 0.6(YT) Government expenditure: G = 100 Lump sum direct tax: T = 100 Investment: I = 200- 10 r Money demand: MD = 0.1 Y - 5 r Money supply: M$ = 50. Where Y is national income, and r is the interest rate (in percent). (a) [5 marks] Derive the IS and LM curves for this economy. (b) [5 marks] Calculate equilibrium national income and the interest rate. (c) [5 marks] Now suppose that full employment national income is Y = 900. The government decides to increase both G and T to 200. Will it achieve full employment? (d) [5 marks] Using your results in (b) and (c) above, comment on the value of the balanced budget multiplier. (e) [5 marks] Suppose instead that, starting from the original position in (a) and (b) above, the central bank aims to achieve full employment (Y = 900) by using monetary policy. What interest rate should it aim to set and by how much should it increase the money supply? [Hint: start with the IS curve].
