Question

Use the IS-LM model to determine the effects of each of the following on the general equilibrium values of the real wage, employment, output, the real interest rate, consumption, investment, and the price level.

Draw the diagrams for each.

(a)?Tougher immigration laws reduce the working-age population.

(b)?There's increased volatility in the prices of stocks and bonds.

(c)?The government tries to achieve tax equity by an increase in the corporate tax rate.

Answer 1

Answer:
(a) The decline in labor supply increases the real wage and reduces employment and
output, shifting the FE line to the left. The LM curve shifts up and to the left as the price
level rises to restore equilibrium. As a result, the real interest rate rises, reducing
consumption and investment.
(b) Real money demand rises, which shifts the LM curve up and to the left. To restore
equilibrium, the price level must decline, shifting the LM curve down and to the right.
There's no effect on any other variable.
(c) The higher tax rate reduces investment, shifting the IS curve down and to the left.
To restore equilibrium, the LM curve shifts down and to the right as the price level falls.
As a result, the real interest rate declines, so consumption increases. There's no change in
the real wage, employment, or output.