Problem Set-I
IS-LM (Numericals)
1. An economy is characterized by the following equations
C = 4 + 0.75Yd
I = 110, G = 120, R = 8, T = 0.2Y
Subsequently, the economy is opened with X = 55 and M = 5 + 0.1Y
(i) Calculate the difference in income in closed economy and open
economy.
(ii) What is budget surplus or deficit in the open economy?
(iii) What should be level of government spending and the rate of tax if
the government wants to achieve full employment level of income of
Rs. 600 and have a balanced budget i.e. G + R = T.
2. C = 150 + 0.75Yd
I = 100, R = 40, X = 35, M = 15 + 0.1Y
G = 115, T = 20 + 0.2Y
Find out:
(i) Equilibrium level of income
(ii) Consumption at equilibrium level of income
(iii) Net exports at equilibrium income balance of trade
(iv) By how much would the equilibrium income change if investment
increases by Rs. 50?
(v) The increase in govt. spending required to ensure that the economy
reaches full employment level of income of Rs. 1200?
3. C = 10 + 0.8Yd
T = 50, I = 135, G = 60, X = 35, M = 0.05Y
Find out ___________
(i) Equilibrium income
(ii) Balance of trade
(iii) The increase in income if both govt. spending and tax were to
increase by Rs. 10 each
(iv) Net exports if export increases by 6.25
(v) The increase in govt. spending read to achieve full employment of
Rs. 825
4. Suppose :
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Problem Set-I
Consumption, C = 50 + 0.6Yd (disposable income)
Investment, I = 35
Govt. Expenditure, G = 25
Taxes, T = 20
Exports, X = 30
Imports, M = 8 + 0.1Y
(figures in Rs. Crores)
(i) Compute the equilibrium level of income.
(ii) If the government wants to achieve full employment level of income
which is Rs. 256 crores, by how much does the government need to:
– Increase G, or
– Increase G and T by the same amount?
Which of these two measures is likely to be preferred by a government
concerned about controlling the budget deficit?
The next four questions (5-8) are based on the following:
Suppose, in equilibrium, aggregate income (in units of money per year) in an
economy Y=C+I, where investment expenditure (in units of money per
year)I=1000 and aggregate consumption expenditure (in units of money per year)
C satisfies the following conditions:
(a) C is a function of current disposable income in the economy (Yd)
(b) If Yd =0,then C=500
(c) Marginal propensity to save out of Yd is constant in the economy
and equal to 30%
Suppose the government collects direct tax revenues equal to 15% of Y and
makes direct transfer payments equal to 750 units of money per year.
5. What is the value of the investment multiplier in the economy?
(a) Between 1.9 and 2.1
(b) Between 2.1 and 2.3
(c) Between 2.3 and 2.5
(d) More then 2.5
6. What is the equilibrium value of Y in the economy?
(a) Between 3250 and 3750
(b) Between 3750 and 4250
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Problem Set-I
(c) Between 4250 and 4750
(d) Between then 4750 and 5250
7. If instead of 750 units of money the government makes annual transfer
payments equal to 10% of Y, then the value of the investment multiplier
will
(a) decrease by less than unity
(b) decrease by more than unity
(c) increase by less than unity
(d) increase by more than unity
8. If instead of 750 units of money the government makes annual transfer
payments equal to 10% of Y, then the equilibrium value of Y will
(a) decrease by less than 1000
(b) decrease by more than 1000
(c) increase by less than 1000
(d) increase by more than 1000
The next Two questions (9-10) are based on the following information: Consider
an open economy simple Keynesian model with autonomous investment (I).
People save a constant proportion (s) of their disposable income and consume
the rest Government taxes the total income at a constant rate and spends an
exogenous amount G on various administrative activities. The level of export
X is autonomous, import M on the other hand is a linear function of total
income with a constant import propensity m. Let
1 2 1
I 3200; G 4000; X 800; s ; ; and m .
2 5 10
9. The equilibrium level of income is given by;
(a) 8,000 (b) 16,000 (c) 10,000 (d) None of these
10. At this equilibrium level of income
(a) there is trade surplus
(b) there is trade deficit
(c) trade is balanced
(d) one cannot comment on the trade account without further
information
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Problem Set-I
11. The following equations describe an economy. (Think of C, I, G, etc, as
being measured in billions and i as a percentage; a 5 percent interest rate
implies
i = 5).
C 0.81 t Y
t 0.25
I 900 50i
G 800
L 0.25Y 62.5i
M/P 500
(a) What is the equation that describes the IS curve?
(b) What is the general definition of the IS curve?
(c) What is the equation that describes the LM curve?
(d) What is the general definition of the LM curve?
(e) What are the equilibrium levels of income and the interest rate?
(f) Describe in words the conditions that are satisfied at the
intersection of the IS and LM curves, and explain why this is an
equilibrium.
12. (a) C = 50 + 0.8(Y – T)
T = 100
I = 150 – 5i
G = 100
L = 0.2Y – 10i
M = 200
P =2
Calculate
(i) Equilibrium income & interest rate.
(ii) If government expenditure increases to 150, find new equilibrium
income & crowing out effect.
(iii) If full employment income is Rs. 1200, calculate change in nominal
money supply required to achieve fill employment.
13. Consider the following IS-LM model:
C 200 .25YD
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Problem Set-I
I 150 .25Y 1000i
G = 250
T = 200
M/P d 2Y 8,000i
M/P 1,600
(a) Derive the IS relation.
(b) Derive the LM relation.
(c) Solve for equilibrium real output.
(d) Solve for the equilibrium interest rate.
(e) Solve for the equilibrium values of C and I and verify the value you
obtained for Y by adding up C, I and G.
(f) Now suppose that the money supply increase to M/P = 1840. Solve
for Y, i, C and I, and describe in words the effects of an expansionary
monetary policy.
(g) Set M/P equal to its initial value of 1600. Now suppose that
government spending increases to G = 400. Summarize the effects
of an expansionary fiscal policy on Y, I and C.
14. Consumption C = 100 + 0.9Yd
Investment I = 600 – 30i
Government expenditure G = 300
Tax T = 1/3Y
Full employment Level of Income = 2500
Demand for Real Balances Md = 0.4Y – 50i
Nominal Money Supply M = 1040
Price level P=2
Note: Do not change the fraction 1/3 in T = 1/3 into decimal.
(i) Derive the IS and the LM equations and compute the equilibrium
levels of income and rate of interest.
(ii) Compute the change required in the level of government expenditure
to achieve the full employment level of income.
(iii) Explain the change in the position and slope of the IS and LM curves
if the MPC changes to 0.6.
15. Consumption C = 100 + 0.8Yd
Investment I = 150 – 6i
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Problem Set-I
Government expenditure G = 100
Demand for real balance Md = 0.2y – 2i
Nominal Money Supply Ms = 300
Price level P=2
(i) Compute the equilibrium levels of income (Y) and the rate of interest
(i)
(ii) Suppose the government purchases are raised from 100 to 150 and
the nominal money supply is raised from 300 to 350. What is the
magnitude of shift in IS and LM curves? What are the new
equilibrium levels of income and the rate of interest?
(iii) For the initial values of monetary and fiscal values, derive the
equation of the aggregate demand curve.
16. Consumption C = 200 + 0.75Yd
Investment I = 926 – 16i
Government expenditure G = 340
Tax T = 0.2Y
Transfer payments TR = 80
Real demand for Money L = 0.2Y – 8i
M
Real Money Supply 200
P
(i) Write down the equation for the IS and LM Curves. Calculate the
equilibrium levels of income and the rate of interest. What would be
the budget surplus corresponding to this level of income?
(ii) How much is the increase in money supply required to increase
equilibrium income by 100?
17. Consumption C = 90 + 0.8Yd
Investment I = 160 – 6i
Government expenditure G = 40
Tax T = 50
Real demand for Money Md = 0.2Y – 4i
Nominal Money Supply Ms=300
Price level P=3
(i) Compute the monetary and fiscal policy multipliers.
(ii) If the full employment level of income is 950. What is the (a) increase
in the nominal supply of money required to achieve full employment;
and
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Problem Set-I
(b) Increase in government expenditure required to achieve full
employment?
(iii) What will be the effect of (a) & (b) on the rate of interest?
18. Consumption C = 85 + 0.75Y
Investment I = 200 – 10i
Government expenditure G = 250
Tax T = 40 + 0.25Y
Transfer Payments TR = 2500
Demand for real Balance Md = 0.2Y – 20i
Nominal Money supply M = 1800
Price level P=3
(i) Compute the equilibrium levels of income and the rate of interest.
(ii) Find the value of the fiscal multiplier.
(iii) By how much would equilibrium income change if government
expenditure increases by 60?
(iv) By how much must real money supply be increased in (iii) above so
that the increased government expenditure has its full multiplier
effect.
19. Consumption C = 50 + 0.8(Y–T)
Tax T = 100
Investment I = 150 – 5i
Government Spending G = 100
Real demand for money L = 0.2Y – 10i
Real money supply M/P = 100
Export X = 20
Imports M = 10 + 0.1Y
(i) Write down the IS and LM equations.
(ii) Compute the equilibrium values of interest rate and income.
(iii) Calculate the trade balance.
20. C = 70 + 0.75Yd
I = 35, G = 28, lump-sum tax (Ta) = 14,
income tax (T) = 0.2Y, X = 72, M = 16 + 0.05Y
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Problem Set-I
(i) Find equilibrium income.
(ii) Consumption at equilibrium income.
(iii) If equilibrium level of income falls short of full employment level of
income by 100, then can full employment be reached by increasing
Government spending by 16 and transfer payment (R) by 12.
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