Question

9. A Change in the Autonomous Consumption: What are the short-run and long-run effects of an increase in autonomous consumption on output, the interest rate and the price level? Use an IS-LM graph and an aggregate demand graph to support your answer. Include a brief explanation in your answer and be sure to properly label your graphs.

10. A Change in Government Spending: What are the short-run and long-run effects of a decrease in government spending on output, the interest rate and the price level? Use an IS-LM graph and an aggregate demand graph to support your answer. Include a brief explanation in your answer and be sure to properly label your graphs.

Answer 1

9). Answer:

Autonomous consumption refers as the expenditures that consumers must make even when they have no disposable income like, food, health, education, cloths etc. When autonomous consumption incraese its increase IS in short run. Increasing IS shift IS curve from IS to IS1. Increasing IS increase interest rate and output in the conomy from r to r1 and Q1 to G2 and the equilibrium point is E2. But in the long-run increasing increasing demand increase price level with output. When price level incraese its decrease the value of real income. Other side high interest rate also decrease the money supply. So, its shift the LM curve left from LM to LM1 and its incraese interest level again from r1 to r3 and output level decrease from Q2 to Q1 or at previous level. New equilibrium point is E3.

10). Answer:

A decreasee in Government Spending will decrease IS and IS curve will shift left in the short run. It will decrease from r1 to r. its decrease output level Q2 ti Q1. In the long-run decreasing interest rate and decreasing price level due to decreasing demand increase the real income or real value of money supply and money supply curve (LM) shift right from LM1 to LM2. Here it will not affect the interest rate but increase output level from Q2 to Q3.