1. Two countries, North and South, have identical closed economies. In the short run both can be described by the IS-LM model. The fiscal authorities of North and South both increase taxes by identical amount. The Central Bank of North follows a policy of holding a constant money supply. The Central Bank of South follows a policy of holding a constant interest rate. Compare the impact of the tax increase on income and interest rates in the two countries. Explain briefly. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values.
2. The economic indicators in the country of Brinkland, a closed economy, signal that the country is in equilibrium, both in the good and services market and in the market for money. You are hired as an advisor to the Central Bank of Brinkland. a. The Congress of Brinkland embarks on a policy to balance the budget and, hence, increases lump-sum taxes. Use the IS-LM model to illustrate the effects of this policy graphically and explain briefly to the central bankers. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values. b. Given the policy above, what should the central bank of Brinkland do if they want to avoid a recession? Illustrate the effects of this policy graphically and explain briefly. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values.
3. Assume that your advice to the central bankers of Brinkland is so effective that its short-run equilibrium real GDP is now at a level above its natural rate. Take this as your starting point and use the IS-LM model to illustrate graphically how the levels of income and interest rates change as the economy of Brinkland returns to the natural rate of output in the long run. Explain briefly. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values.