Question

Explain in detail what effect a tax increase will have on the (1) LM curve; and (2) the IS curve.

Answer 1

1 - When the tax rates are increased , the consumers have lesser money to spend. Due to this , the interest rates in the economy start rising. The rise in the interest rate will allow the upward movement along the LM curve due to decrease in the liquidity in the market.

2 -.Due to the increase in the taxes , there will be lesser money supply in the economy. The decrease in the money supply will shift the IS curve to left or the curve will shift inward denoting the lesser supply of money.