Question

Assume that there is economy with increasing of government expenditure and interest rate and aggregate price level are endogenous. Please use graph to show the increasing by using:

b) IS-LM model

c) AD-AS model with the horizontal aggregate supply curve in the short run

(assume both cases initially started from natural level of income)

Answer 1

a). IS-LM model.

b). AD-AS model showing an economy with increasing government expenditure and interest rate, with Y_1 representing expenditure and Y_f representing interest rate. Note that Y_1 is greater than Y_f when an economy expenditure is increasing more than the interest rate.