Question

In: Economics

show graphically and explain how each of the following policies affect the ISLM model equilibrium a....

show graphically and explain how each of the following policies affect the ISLM model equilibrium

a. government raises taxes in the economy and the central bank conducts open market sales of securities

b.foreign demand for domestic goods increases

Expert Solution

Explanation with graphs as under:

a. government raises taxes in the economy and the central bank conducts open market sales of securities

Higher taxes will shift IS curve to the left
Open market sale of securities will reduce the economy's liquidity (money supply), and shift LM curve to the left

Real GDP level will fall.

Effect on real interest rate is ambiguous - there are three cases:

if shift in IS = shift in LM, r remains unchanged

if shift in IS > shift in LM, r falls

if shift in IS < shift in LM, r rises

b.foreign demand for domestic goods increases

Higher demand for domestic goods will shift IS curve to the right
LM curve remains unchanged - domestic money supply will not immediately change

Real GDP level will rise

Real interest rates will also rise.

The extent of rise of variables will depend on the extent of IS curve shifting - but they will rise in any case.

Rahul Sunny answered 2 years ago

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