Question

3. Explain what effect each of the following events will have on the IS curve in...

3. Explain what effect each of the following events will have on the IS curve in a flexible exchange rate regime: (1) an increase in foreign output; (2) a reduction in the foreign interest rate; and (3) an increase in the domestic interest rate.

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Answer #1

SOLUTION:

1) Increase in foreign output

Increase in foreign output lead to increase in interest rates. As IS curve is downward sloping so, an increase in interest will lead to an decrease in Ouput within the IS Curve.

Diagrammatic representation below ?

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2) decrease in foreign interest rate.

A decrease in foreign interest rate will lead to the interest rate to decrease causing the Output to increase along the IS Curve.

Diagrammatic representation below ?

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3) Increase in domestic interest rate

An increase in domestic interest rates will lead the IS Curve to shift righwards.

Diagrammatic representation below ?

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