Consider the following
Where C is consumption, Yd is disposable income, T is the level of lump sum taxes, I is investment, r is interest rate, G is government spending, (M/P)d is real money demand, Ms is money supply and P is the price level.
(a) Calculate the IS and LM curve and find the equilibrium level of income and interest rate. What is the level of investment in equilibrium?
(b) Concerned that the current level of income is too low, the government announces an expansionary fiscal policy and increases government spending by 200. Find the new equilibrium values of output and interest rates. By how much has investment been crowded out?
(c) The level of income calculated in (b) is full employment level. What might be expected to happen if government does not increase spending by 200 as in (b)?