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Use the IS-LM model to graphically illustrate the impact of a housing crash on output and...

Use the IS-LM model to graphically illustrate the impact of a housing crash on output and interest rate in an economy in the short run. 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. And Write down all changes from the initial equilibrium (the changes in C, I, r, u and Y) to the new short-run equilibrium.

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Answer #1

Aggregate demand = Consumption + Investment + Government spending + Exports - Imports

Crash in housing market put many families into debt and reduce their consumption because they will be paying installment of a house which is actually less worth. Additionally, it will reduce new nvestment which will take place. Both of these factor combined will reduce the aggregate demand in an economy. Fall in aggregate demand will shift IS curve to its left which will reduce rate of interest from "i" to "i1" and output level from "Y" to "Y1". Equilibrium will shift from E to its new short run equilibrium point of E1.

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