Question

For each of the changes in expectations in parts (a) through (d), determine whether there is...

For each of the changes in expectations in parts (a) through (d), determine whether there is a shift in the IS curve, the LM curve, both curves, or neither. In each case assume that no other exogenous variable is changing.

a)a decrease in the expected future real interest rate.

b)a decrease in expected future income.

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Answer #1

a) A decrease in the expected future real interest rate will prompt people to lose the bond holding in the market, as the return that people are expecting will fall in the market and people selling bonds will increase the money supply and shift the LM curve to the right , the new equilibrium will be at a lower interest rate and higher output level. this will not affect the IS curve and only cause a movement along the IS curve to the right.

b) A decrease in the expected future income will make people increase the saving and reduce the consumption this will shift the IS curve to the left and new equilibrium will be at a lower interest rate and lower level of output. this will not affect the LM curve.

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