Department of Economics

Iowa State University

Intermediate Macroeconomics

Fall 2006

Problem Set #2

Alexander

This problem set is due on Thursday, October 12th

The model is: TE = C + I + G

C = a + b ( Y - t Y + TR )

I = c - d i + eY

L = f Y - g i

a. What is the equation that describes the IS curve?

What is the definition of the IS curve?

b. What is the equation that describes the LM curve?

What is the definition of the LM curve?

c. What are the equilibrium values for Y and i?

d. To satisfy a recent election-year promise, Congress decides to reduce taxes. Assume that the tax rate is reduced by .05 (Dt = -.05). What will be the changes in the equilibrium values for Y and i? Show all work!

e. Describe and graphically depict the effect of the change in t on the goods and the money markets (I want a 3 quadrant diagram and an explanation).

f. The increase in the Government's budget deficit creates worries on Wall Street. Investors decide that the economy is overheating and that the budget deficit is out of control. Assume that these pessimistic sentiments lead to a reduction in the income responsiveness of investment demand (De = -.05).What will be the changes in the equilibrium values for Y and i? Show all work!

g. Describe and graphically depict the effect of the change in e on the goods and the money markets (I want a 3 quadrant diagram and an explanation).