Question

1. Which of the following statements correctly describes the short-term response towards a reduction in wealth.

   		The FE curve stays unchanged
   		The FE curve shifts to the right
   		The FE curve shifts to the left
   		None of the above

0.3 points   

QUESTION 10

1. Which of the following statements correctly describes the short-turn response towards an increase in current output

   		The IS curve stays unchanged
   		The IS curve shifts to the right
   		The IS curve shifts to the left
   		None of the above

0.3 points   

QUESTION 11

1. Which of the following statements correctly describes the short-turn response towards a decrease in lump-sum taxes, assuming that households are myopia and do not expect the future tax increase.

   		The IS curve stays unchanged
   		The IS curve shifts to the right
   		The IS curve shifts to the left
   		None of the above

Answer 1

1.FE is a vertical straight line which is derived through labour market equlibrium and production function. Labour market is in equilibrium when demand for labour equals supply for labour. By having equilibrium level of employment we determine the full employment level of output with the production function.

since equilibrium employment is not affected by interest rate it is a vertical straight line. So FE curve shifts only when there is change in capital, technology or employment equlibrium.

As wealth forms a part of capital , a reduction in wealth causes the FE curve to shift to left which leads to lower level of full employment output.

2. IS curve shows the goods market equlibrium which is derived by various combination of interest rate and output. It is a downward sloping curve due to inverse relation between interest rate and output. In goods market investments, government expenditures, exports form injections in addition to consumption which helps to increase aggregate demand in the economy and the level of output. While on the other hand savings, taxes and imports form the leakages which reduces aggregate demand thereby the level of output in the economy .

so when there is an increase in current output in short run IS curve shifts to right .

3. Tax is a leakage in goods market model. When a lump sum tax is imposed and people are short sighted ( myopia) , there is greater chance for reduction in consumption because in short run the entire burden of lump sum tax will be transmitted to consumers who are myopic by producers, will try to reduce consumption inorder to reduce the burden of tax.

As a result the IS curve shifts to left showing a fall in the of aggregate demand and level of output.