Comparing long run effects of the monetary policy also fiscal policy.
Consider the economy of Hicksonia. The consumption function is given by
C= 200 + 0.75(Y-T)
The investment function is
I= 200 - 25r
Government purchases also taxes are both 100. The money demand function in Hicksonia is (M/P)= Y -100r
The money supply M is 1,000
a. Derive also graph also equation for the aggregate demand curve.
Hint : to do this , notice which from the money demand function also the effect which M= 1000 we have which ((1000)/P)=Y-100r
Solving for r we obtain
Use this expression for r to express the investment equation as a function of constants Y an dP. Then use the equilibrium condition in the goods marketplace which
Y= C + I + G
This expression should give you an equation involving P also Y. solve this equation for P as a function of Y . This is the aggregate demand curve which we are looking for.
b. Suppose P=2. Consider an increase in the money supply M from 1,000 to 1,200. Illustrate what happens to this aggregate demand curve? Illustrate what happens to Y/
c. Repeat point (b) where now it is government purchases which increases from 100 to 150 while M=1,000. Illustrate what happens to Y?
d. Repeat point © but now suppose which the government finances the increase in government purchases with taxes also hence in the new equilibrium G= T= 150.
e. Compare the long run effects of the monetary policy in point© also the fiscal policy in point (d).