Question

1. Within the IS-LM curve model, What would be the effect of an autonomous increase in saving that was matched by a drop in consumption-that is ,a fall in a in the consumption function?. C=a + b(Y-T). Which curve would shift? How would income and the interest rate be affected?

Answer 1

An increase in savings shifts the LM curve out and the interest rate falls to a new equilibrium at point C. Increase in income means increase in savings.

Drop in consumption leads to fall in Y hence lowering L and the fall in r raises L.