Question

Indicate which of the following events occurs in the IS-LM space for a closed economy if the government increases investment in higher education

		Y and r both increase
		Y and r both decrease
		Y increases and r decreases
		Y decreases and r increases
		None of the other options is correct

Answer 1

When in the IS-LM model, in the closed economy, the government increases its expenditure on higher education, then Government expenditure rises, So the IS curve shifts upward. This is because government expenditure is part of the IS curve. Thus interest rate increases. Therefore when interest rate increases, then the investment become more expensive, so investment by the firms decreases, so production of goods and services decreases. AD curve shifts leftward, so quantity of real GDP decreases.

It means that Y decreases and r increases.

Hence option fourth is the correct answer.