Thanks to companies like Amazon their is reduced demand for money 1. Focusing on the short-run,...

Thanks to companies like Amazon their is reduced demand for money

1. Focusing on the short-run, use the market for real money balances and IS-L.M models to graphically demonstrate the effects of a reduction in taxes. Label the ares, curves, initial equiibrium, and final equilibrium

2. Explain what happens to output, interest rate, and unemplogment, investment, and consumption.

Solutions

Expert Solution

(1) Lower taxes will increase wealth, increasing the demand for money, shifting money demand curve rightward which increases both interest rate and quantity of money. In IS-LM model, as taxes fall, investment and savings rise, shifting IS curve rightward and increasing both interest rate and output.

In following graph, MD0 & MS0 are initial demand & supply curves for money, intersecting at point A with initial interest rate r0 and quantity of money M0. As money demand rises, MD0 shifts rightward to MD1, intersecting MS0 at point B with higher interest rate r1 and quantity of money M0.

In following graph, IS0 & LM0 are initial IS & LM curves intersecting at point A with initial interest rate r0 & output Y0. Lower taxes shift IS0 rightward to IS1, intersecting LM0 at point B with higher interest rate r1 and higher output Y1.

(2) Output and interest rate increases as a net effect. The immediate effect is a rise in investment and consumption, but in next period both investment and consumption falls due to higher interest rate. Unemployment decreases as an immediate effect.

Rahul Sunny answered 2 years ago

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