a) The Monetary Policy (MP) curve has income, $$ Y $$ on the horizontal axis and real interest rate, $$ r $$, on the vertical axis. Explain what the MP curve shows. What determines its slope? What determines movement along the MP curve? (You do not need to show this mathematically). [ 8 marks] b) Assume the government wants to increase $$ Y $$, without increasing $$ r $$. Using the IS-MP model show how the government can achieve this goal. [ 5 marks] c) Assume the MP curve is given by $$ r=1.0+0.5 \pi $$, where $$ \pi $$ is the inflation rate. The IS curve is given by $$ Y=14-r $$. Derive the equation of the aggregate demand curve. What does the aggregate demand curve look like? If inflation is $$ 10 \% $$ what is the level of output? [10 marks] d) What potential problems may cause policy makers to worry about using the IS-MP model. [7 marks]

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a) The MP curve shows the relationship between the real interest rate and income, typically sloping downward. Its slope depends on investment responsiveness, and movement along the curve is due to changes in the real interest rate. b) The government can increase spending or cut taxes to boost income without raising the interest rate. c) The aggregate demand curve is $$ AD = 13 - 0.5 \pi $$. At 10% inflation, output is 12.95. d) Concerns about the IS-MP model include its simplifications for closed economies, time lags, financial market complexities, and policy failures.

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