Question

Which of the following will cause the IS curve to have a steeper slope?

A. An increase in the marginal propensity to consume

B. A decrease in the tax rate

C. All of these 3 options will

D. A decrease in interest rate sensitivity

Answer 1

FACTORS AFFECTING THE SLOPE OF THE IS CURVE-

The slope of the IS curve depends on two things- the sensitivity of investment spending to the interest rate and the investment multiplier (k).

A) INCREASE IN MARGINAL PROPENSITY TO CONSUME

Marginal Propensity to Consume (MPC) is directly related to the multiplier (k). When there is a reduction in k, the IS curve becomes steep and when k increases, the IS curve becomes flat. So when MPC increases, k also increases, thus making the IS curve flat.

So, an increase in MPC will not make the slope of the IS Curve steeper.

B) A DECREASE IN THE TAX RATE-

When the tax rate increases, k decrease and k increase with a decrease in the tax rates.

A decrease in 'k' will make the IS curve flatter.

So a decrease in tax rates will make the IS curve flatter and not steeper.

C) ALL THREE-

Options A and B will lead to the IS curve being flatter hence option C is not applicable.

D) A DECREASE IN INTEREST RATE SENSITIVITY-

A decrease in interest rate sensitivity leads to the IS curve being steeper because the less the interest rate sensitivity, the lower will be the change in aggregate demand and the less the shift of the IS curve.

So a decrease in interest rate sensitivity will lead to the steepness in the IS curve.

Answer- D

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