Problem

1) Consider an economy described by the following money demand function

L(r,Y) = (M/P)d = 1000 - 100r

where r is the interest rate in per cent and Y is income. The money supply M is 1000 and the price level P is 2.

a. Graph the supply and demand for real money balances.

b. What is the equilibrium interest rate?

c. Assume that the price level is fixed. What happens to the equilibrium interest rate if?the supply of money is raised from 1000 to 1200?

d. If the monetary authority wishes to raise the interest rate to 7 per cent, what money ?supply should it set?

According to the IS-LM model, what happens to the interest rate, income, consumption and investment under the following circumstances?

a. The central bank increases the money supply. ?
b. The government increases government purchases. ?
c. The government increases taxes. ?
d. The government increases government purchases and taxes by equal amounts.