Answer to Question #312512 in Financial Math for richie

Question

Consider a closed economy that is characterized by the following equations:

Y = C + I + G (1)

C = 900 + 0.5(Y − T) (2)

I = 750 − 30r (3)

T = 800 (4)

G = 1200 (5)

Md = Ms

(6)

Ms = 1500 (7)

Mt = 0.7Y (8)

Msp = −80r (9)

Where Y is the GDP, C is private consumption expenditure, I is the Investment expenditure, G

is government expenditure, T is tax revenues, Ms

is money supply, Mt

is transaction demand

for money, Msp is the speculative demand for money and r is the interest rate (in % points).

a) Derive (Md⁄P) the demand for real money balances equation (where P is the aggregate

price level.)

b) Derive the IS and LM equations of the economy (Express Y as a function of r and assume

P is fixed at 1.0.)

c) Calculate the short–run equilibrium values of Y and r in the economy.