Is-Lm Model
Questions to Lecture 7 – IS-LM model and Aggregate demand
1. Draw Keynesian cross as a comparison of planned and realized expenditures. What is the intercept of planned expenditure line? What is its slope? If government expenditures would be positive function of output, how would the Keynesian cross change?
We will go over this on the review session – easier to explain than on paper.
The intersect point represents the equilibrium output.
Black line – planned expenditures
Blue line – realized expenditures
If government expenditures would be positive function of output the blue line would shift up.
2. What are the tools of fiscal policy? Fiscal policy has 3 tools: 1. Increase or decrease government expenditures 2. Cut or increase taxes 3. Increase or decrease transfer payments
3. Explain the mechanism of government expenditures multiplier – why is the effect on the output greater than initial increase in government expenditures? The government purchases multiplier is ∆Y/∆G Initially, the increase in G causes an equal increase in Y, so ∆Y=∆G, But with increasing Y will be increasing C(Y-T) →further ↑Y →further ↑C →further ↑Y So government purchases multiplier will be greater than 1, it is same principal like with Bank’s creation of money when lending out.
4. Explain the mechanism of tax multiplier – why is the effect on the output greater than initial cut in taxes? Increase in taxes reduces consumer spending, which reduces equilibrium income. Firms reduce output, and income falls toward a new equilibrium. Tax multiplier is negative and smaller than G spending multiplier, because consumers save a fraction (1-MPC) of a tax cut so the initial boost is spending from a tax cut is smaller than from an equal increase in G Formula ∆Y=∆C+∆I+∆G
1. Draw Keynesian cross as a comparison of planned and realized expenditures. What is the intercept of planned expenditure line? What is its slope? If government expenditures would be positive function of output, how would the Keynesian cross change?
We will go over this on the review session – easier to explain than on paper.
The intersect point represents the equilibrium output.
Black line – planned expenditures
Blue line – realized expenditures
If government expenditures would be positive function of output the blue line would shift up.
2. What are the tools of fiscal policy? Fiscal policy has 3 tools: 1. Increase or decrease government expenditures 2. Cut or increase taxes 3. Increase or decrease transfer payments
3. Explain the mechanism of government expenditures multiplier – why is the effect on the output greater than initial increase in government expenditures? The government purchases multiplier is ∆Y/∆G Initially, the increase in G causes an equal increase in Y, so ∆Y=∆G, But with increasing Y will be increasing C(Y-T) →further ↑Y →further ↑C →further ↑Y So government purchases multiplier will be greater than 1, it is same principal like with Bank’s creation of money when lending out.
4. Explain the mechanism of tax multiplier – why is the effect on the output greater than initial cut in taxes? Increase in taxes reduces consumer spending, which reduces equilibrium income. Firms reduce output, and income falls toward a new equilibrium. Tax multiplier is negative and smaller than G spending multiplier, because consumers save a fraction (1-MPC) of a tax cut so the initial boost is spending from a tax cut is smaller than from an equal increase in G Formula ∆Y=∆C+∆I+∆G