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Show the effect of a decrease in taxes on the IS curve. Draw the graphs, and...

Show the effect of a decrease in taxes on the IS curve. Draw the graphs, and label them clearly. Also, write down your conclusion in one statement. (3.5 points)

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Answer #1

The IS curve gives the goods market equilibrium. The equation of the IS curve is given by Y=C(Y-T)+I+G. A decrease in taxes has the effect of increasing the disposable income of consumers and so the IS curve will shift rightwards for every level of interest rates. In the diagram below, the initial equilibrium will be (r1,Y1), with the shift of the IS curve to the right the eequilibrium moves to (r2,Y2). A decrease in taxes is thus part of an expansionery fiscal policy, this will cause the IS curve to shift rightwards, causing an increase in interest rates and national output. The economy moves from A to B.

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