Transcript ECON 102 Tutorial: Week 22

ECON 102 Tutorial: Week 22
Shane Murphy
www.lancaster.ac.uk/postgrad/murphys4/econ15
[email protected]
Question 1
Given the macroeconomic system:
IS schedule: r = 8 - 0.006 Y LM schedule: r = - 3 + 0.003 Y
Determine equilibrium values for national income and the
interest rate
r = 8 - 0.006 Y
r = - 3 + 0.003 Y
0 = 11 - 0.009 Y
Y = 11/0.009 =1222.2
r = 8 - 0.006 (1222.222) = 0.667
Question 1
Provide brief explanations of the IS schedule and the LM schedule:
• When interest rates go down, the cost of borrowing money goes down, so
people borrow more. When people borrow more they have more cash to
spend, therefore the amount of things people buy depends on the interest
rate. Thats the IS part. As interest rates decreases, output increases in the
goods market. It slopes downwards.
• When people are rich, they want to hold more money in their wallet instead
of in the bank, which decreases the amount of money in the bank. When
banks have less money in them, the interest rate at which the banks make
loans (interest rate is the cost of borrowing remember) increases. So when
income is high, interest rates are high. Thats the LM part. It slopes upwards.
• The IS/LM model puts these two lines together on the same graph. And
shows how one interest rate puts both the IS side and the LM side in
balance.
Question 2
C = 100 + 0.6 Y
I = 500 - 40 r
G = 200
Lt = 0.4 Y
La = 200 - 50 r
Ms = 600
Y=C+I+G
Md = Lt + La
Md = Ms
Write down the equation of the IS schedule.
S = Y- (100 + 0.6 Y) = 0.4Y - 100
J = I + G = 500 - 40 r + 200
S=J
0.4Y - 100 = 500 - 40 r
40 r = 800 - 0.4 Y
r = 20 - 0.01 Y
Question 2
C = 100 + 0.6 Y
I = 500 - 40 r
G = 200
Lt = 0.4 Y
La = 200 - 50 r
Ms = 600
Y=C+I+G
Md = Lt + La
Md = Ms
Write down the equation of the LM schedule.
L = 0.4 Y + 200 - 50 r
Ms = 600
L=M
0.4 Y + 200 - 50 r = 600
- 50 r = 400 - 0.4 Y
50 r = - 400 + 0.4 Y
r = - 8 + 0.008 Y
Question 2
C = 100 + 0.6 Y
I = 500 - 40 r
G = 200
Lt = 0.4 Y
La = 200 - 50 r
Ms = 600
Y=C+I+G
Md = Lt + La
Md = Ms
Calculate the equilibrium levels of national income and
the interest rate.
r = 20 - 0.01 Y
r = - 8 + 0.008 Y
0 = 28 - 0.018 Y
Y = 28/0.018 = 1555.55
r = 20 - 0.01 (1555.55)
= 20 - 15.555
r = 4.44
Question 3
C = 40 + 0.8 Yd
I = 200 - 20 r
G = 400
t = 0.1
Yd = (1 - t) Y
Lt = 0.3 Y
La = 600 - 120 r
Ms = 300
Y=C+I+G
Md = Lt + La
Md = Ms
Write down the equation of the IS schedule.
Y=C+I+G
Y = 40 + 0.8 Yd + 200 - 20 r + 400
Y = 40 + 0.8(1 - 0.1) + 200 - 20 r + 400
Y = 640 + 0.72 Y - 20 r
20 r = 640 + 0.72 Y - Y
20 r = 640 - 0.28 Y
r = 32 - 0.014 Y
Question 3
C = 40 + 0.8 Yd
I = 200 - 20 r
G = 400
t = 0.1
Yd = (1 - t) Y
Lt = 0.3 Y
La = 600 - 120 r
Ms = 300
Y=C+I+G
Md = Lt + La
Md = Ms
Write down the equation of the LM schedule.
Md = Ms
Lt + La = Ms
0.3 Y + 600 - 120 r = 300
120 r = 300 + 0.3 Y
r = 2.5 + (0.3/120) Y
r = 2.5 + 0.0025 Y
Question 3
C = 40 + 0.8 Yd
I = 200 - 20 r
G = 400
t = 0.1
Yd = (1 - t) Y
Lt = 0.3 Y
La = 600 - 120 r
Ms = 300
Y=C+I+G
Md = Lt + La
Md = Ms
Calculate the equilibrium levels of national income and
the interest rate.
r = 32 - 0.014 Y
r = 2.5 + 0.0025 Y
0 = 29.5 - 0.0165Y
0.0165 Y = 29.5
Y = 1787.88
Question 3
Calculate the impact upon equilibrium when
money in circulation is increased to 450.
IS schedule: r = 32 - 0.014 (1863.6)
LM schedule: r = 1.25 + 0.0025 (1863.6)
• r = 5.91
• Y = 1863.6
Practice Past Exam Questions
(And Questions from Last Year’s
Tutorials)
Please Note: Solutions are not given to tutors for these
questions. The solutions I’ve prepared are only
suggestions only – I cannot guarantee they are correct.
UK National Debt comprises:
(a) the sum of trade deficits over past years
(b) sterling currency notes and coins in
circulation, plus commercial bank deposits
(c) outstanding loans to the state, excluding
sterling currency notes and coins in circulation
(d) outstanding loans to the state, including
sterling currency notes and coins in circulation
2012 Exam Q32
Problem From Last Year
This problem from last year is very similar to Q7, but is written up as a word problem.
See if you can solve it and check your answers against mine in the following slides.
You are given the following information about an economy:
autonomous consumption is £100 billion;
autonomous investment is £500 billion;
the marginal propensity to consume is 0.75;
the coefficient on interest in the marginal efficiency of investment function is 10;
the demand for money function takes the form: MD = 0.5Y – 15r, where Y is the
economy's real output and r is the interest rate expressed as a percentage;
and the real money supply is £850 billion.
Find the equilibrium interest rate (r) and the equilibrium income (Y).
Problem From Last Year
You are given the following information about an economy:
2013/2014
autonomous consumption is £100 billion;
Week 18
autonomous investment is £500 billion;
the marginal propensity to consume is 0.75;
the coefficient on interest in the marginal efficiency of investment function is 10;
the demand for money function takes the form: MD = 0.5Y – 15r, where Y is the
economy's real output and r is the interest rate expressed as a percentage;
and the real money supply is £850 billion.
Find the equations of the IS curve
In the product market, equilibrium occurs when Y = C + I and so:
Note: The coefficient on r is negative here because the lower the
C = 100 + 0.75Y
interst rate, the cheaper it is to invest, so investment will increase.
I = 500 -10r
There is an inverse relationship between the two.
We can plug these in to Y = C + I
Y = 100 + 0.75Y + 500 – 10r
0.25Y = 600 -10r
Y = 2400 – 40r
This is equation of the IS curve.
Problem From Last Year
You are given the following information about an economy:
2013/2014
autonomous consumption is £100 billion;
Week 18
autonomous investment is £500 billion;
the marginal propensity to consume is 0.75;
the coefficient on interest in the marginal efficiency of investment function is 10;
the demand for money function takes the form: MD = 0.5Y – 15r, where Y is the
economy's real output and r is the interest rate expressed as a percentage;
the real money supply is £850 billion.
Find the equations of the LM curve.
In the money market, equilibrium occurs when MD = MS and so:
MD = M S
0.5Y – 15r = 850
0.5Y = 850 + 15r
Y = 1700 + 30r This is the equation of the LM curve.
Problem From Last Year
In part (a) we found:
IS curve: Y = 2400 – 40r
LM curve: Y =1700 + 30r
2013/2014
Week 18
What are the equilibrium income and rate of interest in the economy given the
information above?
To find the equilibrium, set IS equal to LM:
IS = LM
2400 – 40r = 1700 + 30r
70r = 700
r = 10% This is the equilibrium interest rate.
To find the equilibrium income, we can plug this value of r into either expression for
Y and obtain Y = £2,000 billion.
IS Curve is Equilibrium in the Goods Market
To solve for the IS curve set Output (Y) equal to Expenditure
(C+I+G). I is usually a function of interest rate (r). 2013/2014
Week 18
To the up and right of the IS-curve, output is greater than
Expenditure, while to the bottom and left of the IS-Curve,
Output is less than Expenditure.
To shift the IS curve to the
right, we need to increase
Expenditure (usually, I or G).
Likewise, to shift IS to the left,
we would need to decrease
Expenditure.
LM Curve is Equilibrium in the Money Market
To solve for the LM-curve set Money Supply (Ms) equal to
2013/2014
Money Demand (Md).
Week 18
Money Supply is usually constant and Money Demand is
usually a function increasing in output (Y) and decreasing in
interest rates (r).
To shift the LM curve to the
right, we need to increase
Money Supply or decrease
Money Demand (this could be
done through increasing
interest rates).
Likewise, to shift LM to the
left, we would need to
decrease Money Supply or
increase Money Demand
(again, by using interest rates).