Consider the following IS-LM model in a closed economy with prices fixed at (we are in the short run):
Md/P = Y - r
C = 1 + Y/2
I = 1 - r/2
G = G
Ms/P = M/P
Md/P ≤ Ms/P with equality if r>0
Assume that expected inflation is zero.
Explain the minimum value that the real interest rate, r, can take. Derive the IS curve. Write down the LM curve.
Sample Solution