Spreadsheet Project 2: IS-LM Model Building

Use the following equations to build an Excel spreadsheet model of equilibrium in the goods (IS curve) and money (LM curve) markets.

Goods Market: Money Market:
Y = C + I + G (M/P)d = Ms/P
C = a + b(Y - T) (M/P)d = L = hY - jr
I = d - fr Ms/P = M0/P
G = G0 P = 1
T = T0  

Where the following parameter values are defined as:

a = autonomous consumption (a > 0)
b = marginal propensity to consume (1 > b > 0)
d = autonomous investment (d > 0)
f = interest rate sensitivity factor for investment (f > 1)
h = income sensitivity factor for money demand (1 > h > 0)
j = interest rate sensitivity factor for money demand (j > 1)

Steps:

1. You must choose a value for each of the above parameters subject to the restrictions identified in the parentheses above (Hint: Use values similar to the ones you might find on #15 from Problem Set 2). You must also choose initial values for the exogenous policy variables G0, T0, M0. Each of these variables and values should be clearly displayed in your spreadsheet. For example, the parameter and exogenous variable names would go in Column A and their values in Column B.

2. Solve the above model for the equilibrium values of Y and r. You will need to translate the algebraic formula into an Excel formula based on cell addresses that link to the parameter values chosen in Step 1. Clearly display the equilibrium results in a region of your spreadsheet.

3. Create an X-Y Chart of the IS and LM Curves. Please scale the axes appropriately.

4. Answer the following questions based on your model:

Q1: What is the impact on C, I, Y, and r, of a 10% increase in G?

Q2: What is the impact on C, I, Y, and r, of a 10% increase in T?

Q3: What is the impact on C, I, Y, and r, of a 10% increase in M?

Q4: What is the impact on C, I, Y, and r, of a 10% increase in P?

Q5: What is the impact on C, I, Y, and r, of a 10% increase in b?

For each of the above questions, calculate the new values of C, I, Y, and r. Include all of your answers on your spreadsheet file.  Email the spreadsheet file to me by the due date below.

Due Date:  February 24, 2011