Answer each of the following questions. Answers should typically be no more than 2-3 sentences in...

Answer each of the following questions. Answers should typically be no more than 2-3 sentences in length.

1. In the Keynesian cross analysis, explain in your own words why the tax multiplier is smaller (in absolute value) than the government spending multiplier.

2. Explain why the IS curve is downward-sloping using the loanable funds market approach.

Solutions

Expert Solution

1) In Keynesian cross, tax multiplier in absolute terms is MPC/MPS while government spending multiplier is 1/MPS. This shows that tax multiplier is smaller (in absolute value) than the government spending multiplier. The reason is that while increase in spending by government raises the aggregate demand by full, fall in the tax rate raises the aggregate demand by a proprotion which is MPC. The other portion of income which is MPS is saved and not spent. Hence the multplied income in case of tax multiplier is small than what it is in case of the government spending multiplier.

2) IS curve is downward-sloping. This is because a fall in the rate of interest in loanable funds market raises the volume of investment spending. This raises aggregate demand and so the level of GDP rises. Hence when rate of interest rate falls GDP level rises. Hence IS curve is downward-sloping.

Rahul Sunny answered 1 year ago

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