Question

Using IS_LM model. Explain the analysis for the following: Use diagram where necessary.

i) When in an economy, if the interest rate does not affect investment in the goods market, then analyses the impact on the economy? Show by diagram

ii) Impact of increase in money supply in two identical economies having differences in MPCs.

i.e MPC1 > MPC2. Show what high MPC countries will experience.

iii). Rather than boosting, if there is drop in consumer confidence, although thereis increase in money supply.

Answer 1

i)Lower interest rates make it cheaper to borrow. This tends to encourage spending and investment. This leads to higher aggregate demand (AD) and economic growth. This increase in AD may also cause inflationary pressures.

ii) If MPC1>MPC2 then the country with the highest MPC will have a high consumption and savings will increase too. On the other hand the other country experience low consumption rate and low saving rates.

III)When consumers feel more confident about the future of the economy, they tend to consume more. If business confidence is high, then firms tend to spend more on investment, believing that the future payoff from that investment will be substantial. Conversely, if consumer or business confidence drops, then consumption and investment spending decline.