Question

In an IS-LM Model, What happens to output, the money supply, and the path of inflation when: First assume the Fed is moving M to peg r:
a) G ↑
b) T ↑

c) I(.) ↑
d) (MPC at the current Y-T) ↑ e) (MPC at all Y-T) ↑
f) Long Run Y decreases
g) The Fed increases r
h) P ↑
i) expected inflation ↑
j) L(. , .) ↑ for all i, Y

Answer 1

a. As government spending increases, consumptionn, investment, income and ouput will increase. It will boost aggregate demand increases, and shifts IS to right. Iy increases output leve due to higher level of investment. It shifts IS curve to right. As a result, money supply will increase, due to increase in income. It shifts LM curve to right. Rise in aggregate demans increases the level of inflation.
b. As tax rate increases, disposable income will reduce. It reduces consumption level. As tax rate rises, expected return on investment will fall. It reduces investment level. It will decrease aggregate demand. As a result of fall in investment will decrease output. It makes an leftward shift of IS curve. Due to fall in income level, it will reduce money supply. It makes a leftward shift of LM curve. Fall in AD cause decline in inflation level.
C. As investment increases, production, employment, output will also increase. It shifts ID curve rightward. It boost aggregate demand and money supply. It shifts LM to rightward. There by inflation level will rise
d. As MPC at current disposable income rises, investment will increase. It increase the aggregate demand. It shift IS curve to right. Thereby production and output will increase. It will increase money supply and price level in the economy. It shift LM curve to right
e. If MPC at all level of disposable income rises, consumption and aggregate demand in the economy will increase. It shift IS curve to right. It increases, investment, output, and money supply. As a result, inflation will rise. It shift LM curve to right.
f. If long run output decreases, production level will decline. As a result emoployment and income level falls. It reduces aggregate demand and shifts IS curve to left. It reduces output, money supply and inflation. Then it shifts LM curve backward.
g. If Fed increases rate of interest, it will reduce money supply in the economy. It shift LM curve to left. Higher interest rate, reduces investment and production. It reduces output and inflation. It shifts IS curve to left
h. If price level increases, money supply will also rises. It shifts LM curve to right. Increase in money supply reduces rate of interest and which increases production and investment. It shifts IS curve to right.
i. Increase in expected inflation increases the interest rate. It reduces money supply and shift LM curve to left. It reduces inflation. It reduces investment and production and output. It shift IS curve to left.
j. If demand for increases, LM curve shifts back. It increases rate of interest. It pushes down investment, production and output falls. It reduce AD and price level. It shifts IS curve to left.