Consider a closed economy with P fixed: Y=C+I+G, C=c(Y−T) with 0<c<1, I=I−dr (d>0), T=τY (0<τ<1), G=G, money market M/P=L=aY−bi (a,b>0), and i=r+πe. In ceteris paribus, a unit increase in government expenditure has the following impact on equilibrium income:
(Same model.) In ceteris paribus, a unit increase in the expected rate of inflation has the following impact on the equilibrium value of the real interest rate:
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Setup, from Q47 of the paper: Consider a closed economy with P̅ fixed: Y=C+I+G, C=c(Y-T) with 0<c<1, I=I̅-dr (d>0), T=τ Y (0<τ<1), G=G̅, money market M̅/P̅=L=aY-bi (a,b>0), and i=r+π^e. In ceteris paribus, a unit increase in government expenditure has the following impact on equilibrium income: (Same model.) In ceteris paribus, a unit increase in the expected rate of inflation has the following impact on the equilibrium value of the real interest rate: (A) it increases by (1-c(1-τ))/(b[1-c(1-τ)]+ad) units (B) it decreases by a/(a[1-c(1-τ)]+ad) units (C) it increases by (b[1-c(1-τ)])/(b[1-c(1-τ)]+ad) units (D) it decreases by (b[1-c(1-τ)])/(b[1-c(1-τ)]+ad) units
Also written as: Setup, from Q47 of the paper: Consider a closed economy with P_bar fixed: Y=C+I+G, C=c(Y-T) with 0<c<1, I=I_bar-dr (d>0), T=tau Y (0<tau<1), G=G_bar, money market M_bar/P_bar=L=aY-bi (a,b>0), and i=r+pi^e. In ceteris paribus, a unit increase in government expenditure has the following impact on equilibrium income: (Same model.) In ceteris paribus, a unit increase in the expected rate of inflation has the following impact on the equilibrium value of the real interest rate:
IS-LM model has come up 137 times in 7 exams since 2004.
What this question tests
This question is on Extensions: expected inflation, endogenous money and rate targeting, part of IS-LM model in Macroeconomics.
Variations on the basic model: inflation expectations, money supply that responds, and central banks that target the rate.
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