Question

1.

a) Draw and explain an IS-LM graph that explains the economic effects of the lockdown from corona

b) Draw and explain an IS-LM graph that explains the macro-policy response of increasing government expenditure

Answer 1

Aggregate demand = Consumption + Investment + Government expenditure + Exports - Imports

a) Due to lockdown from Corona, there is sudden decrease in investment level because people do not even have money to invest, even they are running out of their savings. There is also sudden decrease in consumption level as consumers are mainly spending money on inelastic good. Decrease in consumption as well as investment level reduce aggregate demand in an economy which shift IS curve to its left from IS to IS1 while LM remains same which result in decrease in rate of interest from "i" to "i1" and decrease in output level from Y to Y1.

b) Increasing government expenditure will raise level of aggregate demand and sift IS curve to its right from IS to IS1 which result in increase in rate of interest from "i" to "i1" as well as increase in output level from "Y" to "Y1".