Final Answers:
a. IS Curve Equation: Y = 3,000 - 400r
b. LM Curve Equation: Y = 3,000 + 100r
c. Equilibrium interest rate: r = 5%; Real output: Y = $2,500 billion
d. Change in equilibrium interest rate: +1%; Change in real output: +$100 billion
e. Change in equilibrium interest rate: +2.5%; Change in real output: +$250 billion
Step-by-step explanation:
The IS curve represents equilibrium in the goods market, expressing the relationship between real output (Y) and the interest rate (r). By combining the consumption function (C), investment function (Ip), government spending (G), and net exports (NX), the IS curve equation is derived, revealing the negative relationship between Y and r. An increase in G to 1,400 shifts the IS curve rightward, leading to an increase in equilibrium Y and r.
The LM curve signifies money market equilibrium, depicting the connection between real output (Y) and the interest rate (r). It results from the money demand (Md) equating money supply (Ms) at a constant price level (P). An increase in Ms/P to 800 shifts the LM curve downward, causing a rise in equilibrium Y and a decrease in the interest rate.
In the initial equilibrium, the interest rate is 5% and real output is $2,500 billion. When G increases to 1,400, the interest rate rises by 1%, reaching 6%, and real output increases by $100 billion to $2,600 billion. Conversely, with G remaining at 1,200 but Ms/P increasing to 800, the interest rate climbs by 2.5% to 7.5%, and real output expands by $250 billion to $2,750 billion.