Derive the equation for is curve

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Reference no: EM131682022

Problem 1:

Expenditure multiplier, autonomous spending, and LM curve are estimated of an economy, as given below:

  • Expenditure multiplier: 2.5
  • Autonomous planned spending function:Ap= 5000 - 200rand
  • LMcurve: Y = 6000 + 300r
  • Where Y is GDP, r is the market interest rate, which include risk premium and term premium andApis the autonomous planned spending. Using the above information:

a. Derive the equation for IS curve. Show both IS curve and LM curves for interest rates between 0 and 10 in a graph.

b. Find equilibrium interest rate and equilibrium GDP using the above information.

c. Suppose the Central Bank introduces a policy to buy junk private bonds to reduce risk, which results in the reduction of risk premium and term premium by 1.5% and 0.5% respectively. Now draw the LM curve and IScurve again taking into account the reduction of risk premium and term premium rates for interest rates between 0 and 10.

d. Using the above IS and LM curve (with the reduction of risk premium and term premium rates), calculate equilibrium GDP and equilibrium market interest rate.

Reference no: EM131682022

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