“The IS curve represents all combinations of interest rates and GDP consistent with product market equilibrium whilst the LM curve represents all combinations of interest rates and GDP consistent with money market equilibrium.”

Identify and briefly explain the theoretical reasons why the IS-LM model was needed

Explain in detail the process by which the IS and LM curves are derived

Your answer should include all relevant diagrams.

                                                                                                            (6 + 14 = 20 marks)                                        

B.

In a four sector model where C = 5000 + .9YD, Io = 1200, Go = 800, T = 600 + .25Y, Xo = 700 and M = 450 + .15Y, YOU ARE REQUIRED TO ANSWER THE FOLLOWING QUESTIONS.

(i)         What is the value of the relevant TAXATION multiplier in this model?     

(ii)        What is the initial value of equilibrium GDP for this economy?

(iii)       Assume that the Full-Employment level of GDP is $ 18,000 million?  What            is the size of the relevant inflationary or deflationary/recessionary gap?

(iv)       Assume that INVESTMENT expenditure increases by $200 million.  What            is the new value of equilibrium GDP after this change?

(v)        Provide 2 factors that could cause INVESTMENT expenditures to increase.

(vi)    Given your results for part (ii) what conclusions can you reach concerning     the economy’s BUDGET RESULT; and the economy’s CURRENT     ACCOUNT RESULT?

Your answers should include all relevant workings and/or calculations.

                                                                                        (2 + 6 + 4 + 2 + 2 + 4 = 20 marks)

.

Question 2

MONETARY ACCOMODATION is a policy that can be used to minimise, if not eliminate, the effects of CROWDING-OUT.  It is also sometimes referred to as TARGETTINGTHE INTEREST RATE.

Explain in detail both of these concepts their relation to contemporary fiscal or budgetary policies.  Your answer should refer to all types of CROWDING-OUT.

Your answers should include all relevant workings and/or calculations.

                                                                                                                  (20 marks)

Question 3

In deriving or obtaining the Aggregate Demand Curve from the IS-LM model, 3 separate effects or methods are used.  These are the “Interest Rate” effect; the “Real Balance/Wealth” effect; and the “Foreign Purchases/International Substitution” effect, respectively. 

Explain in detail how 2 of these 3effects can be used to explain the negative slope of the Aggregate Demand curve.

Your answer should also BRIEFLY identify and explain the various shift factors of the Aggregate Demand curve as well as those factors that determine its slope or gradient.

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