For each of the following situations, show how (if at all) the IS, MP, and AD...

For each of the following situations, show how (if at all) the IS, MP, and AD curves are affected. Show clearly any shifts or movements along the curves. If there is no change, just type “No change in …”

a. A decrease in financial frictions

b. An increase in the current inflation

c. Firms become more optimistic about the future of the economy

d. An autonomous monetary policy tightening occurs

e. An increase in taxes and an autonomous easing of monetary policy happens at the same time

Solutions

Expert Solution

A) The IS curve will shift to its right, MP curve will not shift and the AD curve will shift to its right.

B) An increase in the current inflation rate will lead to a movement along the MP curve, which will further increase the real interest rate and the increase in the real interest rate will bring a movement along the IS curve to lower output ,the increase in inflation represents a movement along the AD curve, reducing output and does not shift the AD curve.

C) Autonomous investment will increase so the IS curve shifts to the right, there will be no change to MP curve shift the AD curve shifts to the right.

D) A decrease in autonomous consumption will shift the IS curve to its left, the MP curve will not shift the and the AD curve shifts to the left.

E) The increase in taxes will shift the IS curve to the left and the easing of monetary policy will move the economy along the IS curve and the tax change will have no affect on the MP curve, but the monetary policy change will shift the MP curve down, the monetary policy easing shifts the AD curve to the right, while the tax increase shifts the AD curve to the left meaning the net effect on the AD curve could not be determined without having information about the relative shifts due to the tax and monetary easing effects.

Rahul Sunny answered 1 year ago

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