1. ECON 102 Tutorial: Week 20 Ayesha Ali www.lancaster.ac.uk/postgrad/alia10/econ102.html a.ali11@lancaster.ac.uk office hours: 8:00AM – 8:50AM tuesdays LUMS C85

2. Today’s Outline  Week 20 worksheet – IS-LM Model:  Please make sure you review all of problems on your own and ask if you have any questions.  If you’re unsure of any solutions here, please see Chapter 24 in your textbook – it provides detailed explanations and examples.  If you didn’t receive your 2 nd exam, you may collect it from my office.  Exam 3 will be available some time after Easter holidays.

3. IS-LM Model: Some Important Equations

4. Question 1

6. Question 2

7. Question 3

8. Question 4

9. Question 5 Assume that MD = 0.2Y – 1,000i, Y = 4,000, i = 5%. By how much would the central bank have to reduce the money supply if it wished to increase the interest rate by 1%? In equilibrium MS = MD MS = 0.2Y – 1,000i If we assume a constant income level Y, then the change in the money supply ΔM is related to a change in interest rate Δi as follows: ΔM = -1,000 Δi ΔM = -1,000 * 0.01 ΔM = -10 So the central bank would have to reduce the money supply by 10. Alternatively, we could get the same result by inserting the value for Y and the two different values for i into the MS = MD equation and calculating the two money supply values, and then fining the change in money supply required.

10. Question 6 Assume that MD = 0.2Y – 1,000i, Y = 4,000, i = 5%. By how much would the central bank have to let the interest rate change if it cuts the money supply by 100? In equilibrium MS = MD MS = 0.2Y – 1,000i We re-arrange to isolate i: i = (-1/1,000)(0.2Y + M) So, if we hold income, Y, at a constant, then the change in the interest rate Δi is related to a change in money supply ΔM as follows: Δi = (-1/1,000) ΔM Δi = (-1/1,000) * (-100) Δi = 0.1 = 10% So the interest rate would rise by 10 percentage points.

11. Question 7

12. Question 8

14. Question 9

16. Next Class  Week 21 Worksheet - Fiscal Policy & Monetary Policy  Looks at Policy Applications of the maths that we used in this week’s tutorial.  Chapters 25 and 26 in the Textbook  Have a nice Easter Break!