Question

Briefly explain whether and if so how an increase in firms' markup affects the (i) IS curve, (ii) the LM curve, and (iii) the Phillips curve.

Answer 1

Considering that increase in firms markup suggests that all the firms in an economy is now earning higher price relative to the cost. This means, margins for the companies is going up.

If profit margins increase then Investment will increase, as firms want to invest more and produce more.

Equation of IS curve is

(S-I) = (G-T) + (X-M)

Now, is I increases then we can say that IS curve shifts to the right.

S- Savings, I - Investments, G- Government spending, T - Taxes, X- Exports, M - Imports

Now, if markups are increasing then price level are going up. So, it can be said that M/P will decrease.

Decrease in M/P will shift LM curve to left.

M- Nominal money supply, P - Price levels

So, overall, there will be higher output at higher prices in an economy.

This will lead to higher inflation and higher employment.

So, it can be said that phillips curve is moving towards right.