Question

For the economy below, Government spending equals G and the real money supply equals M/P, i.e. you have not been given numerical values for these variables. The G and M/P terms should be included in your answers where appropriate. The tax rate t=.4. Show all work. a. Solve for the IS curve .

Answer 1

To solve for the IS curve, we need to find the equilibrium level of output where aggregate demand equals aggregate supply. This can be done by calculating aggregate demand and substituting the given values into the equation. To calculate the change in government spending needed to achieve potential GDP, you can use the multiplier concept.

Step-by-step explanation:

To solve for the IS curve, we need to find the equilibrium level of output where aggregate demand equals aggregate supply. In this case, aggregate demand is the sum of consumption, investment, government spending, and net exports. Aggregate supply is equal to potential GDP. Here are the steps to solve for the IS curve:

1. Aggregate demand (AD) = C + I + G + X - M
2. Substitute the given values for consumption (C), investment (I), government spending (G), net exports (X-M), and potential GDP into AD.
3. Solve for equilibrium output by setting AD equal to potential GDP: AD = 3500
4. Calculate the change in government spending needed to achieve this equilibrium by subtracting the given government spending (G) from the solution for government spending (G) in the previous step.

To calculate the multiplier, we can use the formula: multiplier = 1 / (1 - marginal propensity to consume). In this case, the marginal propensity to consume is 0.85. The change in government spending needed to achieve potential GDP can then be calculated by multiplying the multiplier by the change in GDP.