# Workshop #3

## Deriving IS and LM curves for use in policy analysis

Let us suppose an American economy with the following characteristics: the MEC curve looks like this: I = 550 - 10i,
the aggregate savings function
is S = -15 + .2Yd, where Yd = Y - T,
the money demand function is i = 25 + .007Y - .08Md,
government expenditures are 450
the Treasury is operating an income tax which can be characterized as T = 186.1 + .05Y,
and Greenspan and the Fed have the money supply at Ms = 500.

### Now, answer the following questions based on the above data.

a) Derive an IS and LM solution from this data, graph it, then compute the equilibrium rate of interest, the level of GNP or Y, and the government budget surplus or deficit.

b) Then, suppose you have reason to think that full employment Y = 3400. By how much would you have to expand the money supply to attain this level of Y? What interest rate would this give? What would happen to the government budget?

c) Finally, suppose you are dependent on foreign money to finance your deficit (as with the US today) and are affraid that a drop in interest rates of this magnitude would result in foreign capital going home. How else might you raise Y to 3400?