Question

Using IS-LM analysis, illustrate the effect of a decrease in the money supply on equilibrium interest rate and output. Explain what you are illustrating in your diagram and why the curve(s) are moving.

Answer #1

When the money supply is decreased the for a given level of
income/output, interest rate rises. This happens because with the
decline in money supply people will start to withdraw money from
their speculative balances to finances their transaction needs. To
keep the money market in equilibrium, the interest rate will rise
from r_{1} to r_{2}.

Increase in the interest rate will result in the decline in the
investment level. This happens because, with an increased interest
rate, borrowing for the purchase of machinery or for building
plants becomes expensive for the firms. The decline in the
investment causes a decline in the income/output in the economy
from y_{1} to y_{2}.

**So, a decrease in the money supply causes interest rate
to rise and income/output to decline in the economy.**

Use the IS-LM model to predict the effect of an increase in the
money supply on output, Y , and the real interest rate, r in the
short-run.
What is the effect of this policy on these variables in the
long-run? How do you know?

Graphically (using the IS-LM model) illustrate and explain what
effect an increase in default-risk premium (x) will have on the
equilibrium output. How can we restore teh output to its original
level following this change?

Based on the Aggregate Supply and Aggregate Demand model, and
the IS-LM model, graphically illustrate and explain what effect an
increase in the money supply will have on the economy. In your
graphs, clearly illustrate the short-run and medium-run
equilibria.
Draw both the IS-LM and the AD-AS models.

Use the IS-LM model to graphically illustrate the impact of a
sudden decrease in demand for money (due to an increase in the use
of internet banking) on the output and interest rate in an economy
in the short run. Write down the impact on Y, C, U and
I.
Be sure to label: i. the axes; ii. the curves; iii. the initial
equilibrium levels; iv. the direction the curves shift; and v. the
new short-run equilibrium.

Use the IS-LM model to answer this question and assume that the
central bank controls the
interest rate. Suppose there is a simultaneous decrease in taxes
and decrease in interest rate.
a. Explain what effect this particular policy mix will have on
output and the money supply.
b. Based on your analysis, do we know with certainty what effect
this policy mix will have on
investment? Explain

1. Using the IS-LM graphs, explain what will happen to output
and the interest rate if consumers suddenly become pessimistic and
decrease their consumption spending at all levels.
2. Using the IS-LM graphs, explain what will happen to output
and the interest rate if financial panic leads to an increase in
the demand for money.

illustrate why money is non-neutral in the Keynesian
Macroeconomic Model. What effect does a decrease in the money
supply have on the economy?

Question 1
By relying on the IS LM Model explain what will be the effect of
a tax cut policy on the equilibrium level of income. Explain in
detail the different steps, how does this policy impact the
investment?
Question 2
Keynesian economics assume that prices are sticky (they do not
change) in the short run. It is an assumption shared by classical
economics. Explain briefly what are the characteristics of
classical economists and according to them what drives the...

For each of the following situations, use the IS-LM-FX model to
illustrate the effects of the shock. Please explain how you
obtained your answer (do not just state the effect). For each case,
state the effect of the shock on the following variables (increase,
decrease, no change, or ambiguous): Y, i, E, C, I and TB. Assume
the government allows the exchange rate to float and makes no
policy response.
1. The money supply increases.
2. Government spending increases.
3....

An increase in money supply shifts the LM curve to the right,
but an increase in money demand shifts the LM curve to the left.
Giving reasons, explain why there is a difference. (150 words
maximum)

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