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# ECON 352 Problem Set 3

Subject: Economics / Accounting
Question
Due beginning of class on March 20 (Monday)
1. Consider an economy described by the following equations:
C = 200 + 0.75(Y ? T )
I = 200 ? 25r
G = 100
T = 100 L(r, Y ) = Y ? 100r
M = 1, 000 P = 2 (a) (1 point) Derive the equation for the IS curve.
(b) (1 point) Derive the equation for the LM curve.
(c) (1 point) What is the equilibrium interest rate r and the equilibrium level of income Y ?
(d) (1 point) What is the government purchases multiplier?
(e) (1 point) What is the tax multiplier?
(f) (2 points) Suppose that the government purchases are raised from 100 to 150. How does
the IS curve shift? What are the new equilibrium interest rate and level of income?
(g) (2 points) Suppose instead that the money supply is raised from 1,000 to 1,200. How
dose the LM curve shift? What are the new equilibrium interest rate and level of income?
(h) (2 points) With the initial values for monetary and fiscal policy, suppose that the price
level rises from 2 to 4. What happens? What are the new equilibrium interest rate and
level of income?
(i) (3 points) Derive the Aggregate Demand (AD) curve.
2. Suppose money demand depends on disposable income, so that the equation for the money
demand becomes
M
P d
= L(r, Y ? T ). 1 (a) (3 points) Analyze the effects of a tax cut in an IS-LM model. How does the tax cut
shift the IS curve and the LM curve? How are equilibrium interest rate and level of
income different from its original level?
(b) (3 points) Analyze the effects of an increase in the government purchases in an IS-LM
model. How does the increase in government spending shift the IS and the LM curve?
How are equilibrium interest rate and level of income different from its original level?

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