IS/LM diagram
1. Draw an IS/LM diagram which shows a macro equilibrium
(use the â??intermediate range for the LM curve — assuming the absolute value
of lâ?? is less than infinity and greater than 0). Indicate the equilibrium
interest rate by ro, and the equilibrium level of income by yo.
2 . Now suppose there is an increase in government spending
financed by the Treasury selling bonds to the public (a pure fiscal policy).
a) Show the appropriate shifts in the IS and/or LM curve in
the above diagram.
b) Indicate the new equilibrium income and interest rate by
y1 and r1.
c) State what has happened to equilibrium income and
interest rates.
d) Is the level of investment spending higher or lower than
at ro,yo?
e) Has money demand changed? If so, how?
f) If the LM curve had been totally inelastic (lâ??=0) with
respect to interest rates (vertical) would your answers to b) and e) change? If
so, how and why.
