Question

Suppose a country using the Canadian system of measuring unemployment statistics has 100 million people, of who 50 million are of working age. Of these 50 million, 20 million have jobs. Of the remainder: 10 million are actively searching for jobs; 10 million would like jobs but are not searching; and 10 million do not want jobs at all.

An increase in government spending when there is an interest rate target leads to:

A) an increase in output, the money supply, or the interest rate.

B) an increase in output, a decrease in the money supply, and a decrease in the interest rate.

C) a decrease in output, an increase in the money supply, and no change in the interest rate.

D) an increase in output, an increase in the money supply, and no change in the interest rate. E) no change in output, the money supply, or the interest rate.

Answer 1

If we use the IS-LM framework when there is an increase in the government spending, The IS curve will shift to the right. Increased government spending also increases the level of Money supply in the economy. When Money supply increases the LM curve also shifts to the right. Now there is an interest rate target, suppose the government does not want to increase the Interest rate level in the economy so to achieve that the shift in IS curve is exactly equal to the shift in LM curve. This will result in an increase in the output, an increase in the money supply and no change in the interest rate. so Option-D is the correct answer.

Remember it is about the target. If government wants to increase(decrease) the interest rate then shift in IS curve is more(less) than the shift in the LM curve respectively.