321 Tutorial 1

UNIVERSITY OF BOTSWANA
DEPARTMENT OF ECONOMICS
ECO 321 TUTORIAL SET 1
1. Consider the following IS-LM model with a central bank controlling the
interest rate:
C = 200 + 0.25Yd
I = 150 + 0.25Y − 1000i
G = 250, T = 200
M𝑑
= 2Y − 8000i
𝑃
i = 𝑖0 = 0.05
a. Derive the IS equation.

b. Derive the LM equation
c. Solve for the equilibrium real output.
d. Solve for the equilibrium real money supply
e. Solve for the equilibrium values of C and I.
f. Now suppose that the interest rate was cut to 3%, solve for the new
equilibrium values of output, money supply and consumption and
investment. Describe the effect of this monetary expansion in words.
g. Set the interest rate back to 5%. Now suppose that the government
increases its expenditures by 200. If the central bank maintains the
interest rate at 5%, what will be the effect of the fiscal expansion on
output and consumption.
2. Discuss the effectiveness of monetary policy under the following scenarios:

a. Money demand is highly interest elastic
b. Money demand is highly interest inelastic
c. Investment is highly interest elastic
d. Investment is highly interest inelastic
3. Discuss the effectiveness of fiscal under the following scenarios:

a. Money demand is highly interest elastic
b. Money demand is highly interest inelastic
c. Investment is highly interest elastic
d. Investment is highly interest inelastic
4. How will a contractionary monetary policy affect the following variables

within the IS-LM model:
a. The interest rate.
b. Equilibrium output.
c. The components of output.
5. Graphically illustrate and explain the impact of an increase in the budget
deficit, under the following cases:
a. The central bank controls the money supply and keeps it constant.
b. The central bank controls the interest rate, and keeps it constant.
6. Assume that consumption is described by a linear function:
C = c0 +c1YD.
Using the IS-LM framework, analyse the effects of an increase in consumer
confidence on the economy i.e. equilibrium output, interest rate, money
supply, consumption and investment, under the following 2 scenarios:
a. The central bank controls the money supply and keeps it constant.
b. The central bank controls the interest rate, and keeps it constant.
7. Suppose the interest rate on bonds is zero. Would people want to hold bonds
or to hold money? Explain.
8. Explain the limits of fiscal policy.
9. Consider the following model of the economy:
𝐴𝑆: 𝑃𝑡 = 𝑃𝑡𝑒 + 𝑑(𝑌𝑡 − 𝑌𝑛 )

𝐼𝑆: 𝑌𝑡 = 𝑏 − 𝑐𝑖𝑡 + 𝑒𝐺 − 𝑓𝑇
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑟𝑢𝑙𝑒 : 𝑖𝑡 = 𝑖𝑛 + 𝑎(𝑃𝑡 − 𝑃𝑇 )
Where, a, b, c, d, e and f are positive parameters, 𝑌𝑛 is the natural level of
output, 𝑃𝑇 is the price level target, 𝑖𝑛 is the neutral interest rate and G and T
are government expenditures and taxes respectively.
a. Solve for the AD equation.
b. Suppose PT =1, Yn=100, b=101, c=100, e=2, f=1, G=T=0 . What are the
medium run values of P, Y and i?
10. Consider the following model of the economy:
𝑊 = 𝑃𝑒 (5 − 40𝑢)
𝑊
𝑃 = (1 + 𝑚) , 𝑤ℎ𝑒𝑟𝑒 𝑚 = 0.6
𝐴
𝑌 = 𝐴𝑁, 𝑤ℎ𝑒𝑟𝑒 𝐴 = 1
𝐿 = 100
𝐶 = 10 + 0.5 (𝑌 − 𝑇)
𝐼 = 12 + 0.3𝑌 − 1000𝑖
𝐺 = 100, 𝑇 = 90
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑟𝑢𝑙𝑒 : 𝑖𝑡 = 𝑖𝑛 + 2(𝑃𝑡 − 10)
a. Derive the AS relationship for this economy.
b. Find the natural rate of unemployment and the natural level of
employment.
c. Derive the IS relationship for this economy.
d. Derive the AD relationship for this economy
e. What are the medium-run values of P, Y and i?
11. Consider an economy in its medium run equilibrium described as follows:

𝐴𝑆: 𝑃𝑡 = 𝑃𝑡𝑒 + 𝑑(𝑌𝑡 − 𝑌𝑛 )
𝐼𝑆: 𝑌𝑡 = 𝑏 − 𝑐𝑖𝑡 + 𝑒𝐺 − 𝑓𝑇
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑟𝑢𝑙𝑒 : 𝑖𝑡 = 𝑖𝑛 + 𝑎(𝑃𝑡 − 𝑃𝑇 )
Where, a, b, c, d, e and f are positive parameters, 𝑌𝑛 is the natural level of
output, 𝑃𝑇 is the price level target, 𝑖𝑛 is the neutral interest rate and G and T
are government expenditures and taxes respectively.
a. Suppose that the central bank increases its price level target. Use the
AS-AD approach to analyse the effect of this policy change on the short
run and medium run equilibria.
b. What will be the effect if the central bank raises the neutral interest
rate, in.
12. Suppose that there is a decrease in the budget deficit. Using an appropriate
graph, analyse the effects of this decrease in the budget deficit on the
economy in both the short run and the medium run within AS-AD framework.
13. Using the AS-AD model where the central bank uses an interest rate rule with
a price level target. Assume that before the changes the economy was in the
medium run equilibrium. Suppose the central bank decreases the natural rate
of interest in.
a. Graphically illustrate and explain the effects of this policy change in the
short run.
b. Then show the effect on output and the price level in the medium run.
c. Show what happens if the economy gets into a liquidity trap.

321 Tutorial 1

Uploaded by

Copyright:

Available Formats

321 Tutorial 1

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

321 Tutorial 1

Uploaded by

Copyright:

Available Formats

UNIVERSITY OF BOTSWANA

a. Derive the IS equation.

2. Discuss the effectiveness of monetary policy under the following scenarios:

3. Discuss the effectiveness of fiscal under the following scenarios:

4. How will a contractionary monetary policy affect the following variables

𝐴𝑆: 𝑃𝑡 = 𝑃𝑡𝑒 + 𝑑(𝑌𝑡 − 𝑌𝑛 )

11. Consider an economy in its medium run equilibrium described as follows:

You might also like