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1. Show what happens to Y and r using the IS-LM model when a) There is...

1. Show what happens to Y and r using the IS-LM model when

a) There is a decrease in money demand

b) Congress reduces government spending

c) There is an increase in consumption spending by househol

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Answer #1

a) A decrease in money demand shifts money demand function down and there is reduction in the interest rate. This can be seen as an outward shift/rightward shift of the LM curve. Interest rate is reduced and output is increased (due to increased spending with lower interest rate)

b) Government's contractionary fiscal policy will reduce aggregate spending so IS shifts left. This reduces both the rate of interest and the level of GDP

c) Higher consumption will stimulate spending so there is a rightward shift of IS curve. Interest rate is increased and there is an increase in the level of GDP.

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