Explain how you can use the IS-LM and AD-AS models to predict the future and explain...

Explain how you can use the IS-LM and AD-AS models to predict the future and explain the past.

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Expert Solution

The ISLM model is related to the AD-AS set up in that the ISLM equilibriums form the locus of points on the AD curve. The IS curve shifts due to changes in monetary and fiscal policy which in turn causes the AD curve to shift. So for instance if the government uses an expansionery monetary policy through a cut back in interest rates then this allows us to predict in the future that the LM curve will shift rightwards causing a fall in the interest rates and a rise in the output level. Thus the shifts in the LM curve allow a prediction of which way the output level and interest rates will move. Similarly a cut back in taxes through an expansionery fiscal policy will allow a prediction that through an increase in disposable income there will be an increase in output and the interest rates. Thus monetary and fiscal policies will show how IS and LM curves will shift and so help determine the future through changes in the aggregate demand.

Rahul Sunny answered 1 year ago

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