Question

1. Given a proportional tax system, use an IS-LM diagram to explain the impacts of an increase in income sensitivity of private investment b1 on equilibrium output, interest rate and private investment? Use an IS-LM diagram and some sentences to explain your answer.
2. Given a lump sum tax system (T), if the public sector (including both the government and the central bank) attempts to adjust the structure of the economy by encouraging more private investment, private consumption and reducing the significance of the public demand, what kind of policy mix can be introduced? Use an IS-LM to explain your answer in details.
3. Can the government and the central bank work together to prevent crowding out effect? Use an IS-LM diagram to explain the steps. What should be done by the government and the central bank? Explain your answer.

Answer 1

A-3) I Inuestment spending is very sensitive to the interest rate then a ginen change in interest rate produces a large change in aggregate demand which leads to large change in equilibrium lenel & income. which makes Is curne Hatter. This can be depicted in diagram below: Is caurue becomes flatter as is' and small changes in rate of Interest interest leads to large change in private a Innestment and output in the the economy. National & Output LM Rate