Question

As the IS curve becomes flatter, we know that

A. a given change in the money supply will cause a larger change in output.

B. a given change in the money supply will cause a smaller change in output.

C. a given change in the money supply will cause the same change in output.

D. monetary policy becomes less effective.

E. All the other answers are incorrect

The flatter is the IS curve,

A. the more effective is monetary policy.

B. the less effective is monetary policy.

C. the effectiveness of monetary policy does not change.

D. a given change in the money supply will have a smaller effect on output.

E. All the other answers are incorrect

Please give some detailed explanation

Answer 1

1. The correct answer is (a). A given change in money supply will cause of larger change in output. This is because a given change in monetary policy will shift the LM curve in the forward direction. Now, this forward shift will lead to greater output only when intersects a flatter IS curve. This is because a flatter IS curve would ensure lesser change in interest rates causing a greater change in output. The change in output will be small if the IS curve becomes steeper.

The attached diagram will make this more clear.

2. The flatter is the IS curve, the more effective is the monetary policy. Thus, the correct answer is (a). This can be understood by the same logic applied in above question and the same diagram attached.

We can clearly observe that as the IS curve keeps gettig flatter, the change in output will be more. Now, the objective of the monetary policy is to raise the level of output. Thus, we can say that the level of output is increased to the greatest extent when the IS is flatter. Thus, monetary policy is more effective, the flatter the IS curve.