Question: consider first the goods market model with constant investment c...
Consider first the goods market model with constant
C = c0 + c1 (Y-T)
and I, G and T are given.
(a) Solve for equilibrium output. What is the value of the multiplier?
(b) Now, let investment depend on both sales and the interest rate:
I = b0 + b1Y - b2i:
Solve for equilibrium output. At a given interest rate, is the effect of change in autonomous spending bigger than what it was in (a)? Why? (Assume c1 + b1 < 1).
(c) Next, let us introduce the financial market equilibrium condition with real money demand equal to real money supply.
= d1Y - d2i:
Solve for equilibrium output. (Hint: Eliminate the interest rate in the IS equation using the expression from the LM equation.) Derive the multiplier (the effect of a one-unit change in b0 on output).
(d) Is the multiplier you obtained smaller or larger than the multiplier you derived in your answer to (a)? Explain how your answer depends on the behavioral equations for consumption, investment and money demand.