The following parameters describe the structure of a hypothetical economy:
Autonomous consumption=240
Autonomous investment=1000
Autonomous taxes=100
Autonomous government expenditure=400
Real money supply (M/P)=600
Tax rate=0.25
Marginal propensity to consume=0.8
Interest elasticity of investment=50
Interest elasticity of demand for money=62.5
Income elasticity of demand for money=0.25
a) Determine and explain the relative effectiveness of fiscal and
monetary policies. Use your answer to determine equilibrium income and interest rate.
b) State the values of the fiscal and monetary policy multipliers if the economy is in a
liquidity trap. Explain.
c) If government expenditure is increased by 150 units, show how equilibrium interest
rate and equilibrium income will change. Can you determine the extent to which
investment is crowded out as a result? Explain.