Question #63293

You are given the following information of commodity market and money market of a closed economy without government intervention.
The commodity market consumption function C = 50 + 2Y
5
Investment function I = 790-21r
Money Market:
Precautionary and Transaction demand for money.
MDT = 1Y
6
Speculative demand
MDS= 1200-16r
Money supply
MS= 1250
1. Determine the;
i) Equilibrium level of income.
ii) Interest rate for this economy.
2. Using a well labeled diagram, Illustrate the equilibrium condition in part i) above.

Expert's answer

C = 50 + 2/5Y, I = 790 – 21r

MDT = 1/6 Y, MDS = 1200 -18r, MS = 1250

In equilibrium Y = C + I and MD = MDT + MDS = MS, so:

50 + 2/5Y = 790 – 21r

1/6 Y + 1200 - 18r = 1250,

2/5Y + 21r = 740

1/6Y - 18r = 50 -> 2/5Y - 43.2r = 120, so if we subtract second equation from the first, we will get:

64.2r = 620

r = 9.66%

Y = (740 - 21*9.66)/0.4 = $1343

So, r = 9.66% and Y = $1343 are the equilibrium levels of income and interest rate for this economy.

MDT = 1/6 Y, MDS = 1200 -18r, MS = 1250

In equilibrium Y = C + I and MD = MDT + MDS = MS, so:

50 + 2/5Y = 790 – 21r

1/6 Y + 1200 - 18r = 1250,

2/5Y + 21r = 740

1/6Y - 18r = 50 -> 2/5Y - 43.2r = 120, so if we subtract second equation from the first, we will get:

64.2r = 620

r = 9.66%

Y = (740 - 21*9.66)/0.4 = $1343

So, r = 9.66% and Y = $1343 are the equilibrium levels of income and interest rate for this economy.

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