Question

1. In the IS-LM model, analyze the effects of increased optimism of wealth-holders on all the endogenous variables (Y, r, I, S, C, T, L1, L2).

Answer 1

The increase optimism of wealth holders is the future speculation of reduced interest rate.

The investment has inverse relation with interest rates, that is, when the rates are reduced, then the investment will be increased.

The IS - LM model is a macroeconomic model which describes how the product market interacts with money market and how it affects economic growth.

When the rate would be reduced then, it would lead to increased investment, which would lead to increased output and income (Y).

The increased income (Y) will lead to increased consumption (C) and spending.

Even though, the income would be increased but the lower interest rate will discourage people to save, in addition increased consumption will lead to reduced savings (S).

The increased income will lead to increase in tax revenue (T).

The incraesed investment, income, consuption and reduced saving will lead to increase in L1 and L2.

Hence, in overall the liquidity will be increased, and economy will move with positive growth.