Question

Suppose that policymakers want to decrease the fiscal deficit.

3. Suppose that policymakers want to decrease the fiscal deficit A. Use an IS-LM graph to illustrate the effect on equilibrium GDP and interest rates if government spending is decreased, explaining briefly what happens. B. Use an IS-LM graph to illustrate the effect on equilibrium GDP and interest rates if taxes are increased, explaining briefly what happens. C. Suppose the policymakers want to reduce the fiscal deficit without decreasing GDP. Is there a fiscal-monetary policy mix that can achieve this goal? Use an IS-LM graph to illustrate your suggestion.

Answer 1

The is came is function of = c + 1 + G & closed economy] 4 = c(u-t) + I (ai) + G + NX lopen ecaway) ie. exports expuolina 9 The IS-LM cuerus am draun ou as function of incom). autput aut intuest rate. The graphical vespresentation can help us better undustand the effect of decrease of gout spending on income and interest voch The first gereeph shows how plan and output is equal to aggangate demand this is sised to deurse the is curre in the graph below. An autonomous decucene in gout. spending vedures of output GDP land from intausta 4, to uz and correspondingly is shifts fran Is, ho left to Isz. for ginen monry demand, purue lund (cm anne), the output (GDP) and inkiest vote falles. 4 4 vutt ISI IS Y Y GDP

3 when taxes are increased the spending) income of consunius fall, hence the aggregate demand fall in the eromary. This will led to leffwand shift in I5 came, and oupal GPP) and interest rates will fall. . interest vate LM cuore " GDP The LM were will not of liquidity demand and hold at a time. change cash as it is function people want to G Fiscal deficit eufees when the gouwment spindung is more than the taxes it collects. Therefore the gout. will have to increase it's taxes in order to watch the difference fomune, as seen about macase in taxes will lead to leffurand shift in is and fall in GDP and intered rate. In order to avoid. this we will it use EXPANSIONARY MONETARY Policy. The momy supply will increase in econory, It will led to stutt shift of LM cwum to s eliput Banned with CamScanner

As mony so is mony supply increases, intwest rate falls therehe unfors to invest and increasing GDP and beninging back to revigised equilibrium encouraging innen untant rati ISI GDP output oncreases till uz and As sun in diaguan inccese vati is ez. Scanned with CamScanner