Suppose the stock market crashes resulting in a significant decline in the wealth of consumers. Make...
Suppose the stock market crashes resulting in a significant decline in the wealth of consumers. Make use of the IS-MP model to illustrate the impact this has on real GDP, and show how the Fed could restore the output level by lowering the real interest rate.
Homework Answers
The IS curve shifts to the left as a result of the stock market crash.The interest rate and income falls.Consequently the wealth of the consumers falls, reducing aggregate demand.AD curve shifts to the left, reducing price and output.
If the central bank intervenes by raising the money supply,the MP curve shifts to the right.Interest rate falls further but income rises.A fall in interest rate increases investment,this AD rises.AD shifts to the right (AD' to AD)increaing price level and output.
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