Question

（1）What is the impact of an increase in taxes on the interest rate, income, consumption, and...

（1）What is the impact of an increase in taxes on the interest rate, income, consumption, and investment? Use the IS-LM model to answer this question.

（2）What is the impact of a decrease in the money supply on the interest rate, income, consumption, and investment? Use the IS-LM model to answer this question.

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Answer #1

SOLUTION:-

In both IS-LM graphs, IS0 & LM0 are initial IS & LM curves intersecting at point A with initial interest rate r0 and output Y0.

(1)

An increase in tax decreases Consumption and Investment. Hence, IS curve will shift leftward, decreasing both interest rate and output. A decrease in output decreases income

In following graph, IS0 shifts lefts to IS1, intersecting LM0 at point B with lower interest rater r1 and lower output Y1.

(2)

A decrease in money supply shifts LM curve leftward, increasing interest rate and decreasing output. A decrease in output decreases income, consumption and investment.

In following graph, LM0 shifts left to LM1, intersecting IS0 at point B with higher interest rate r1 and lower output Y1.

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