Answer to Question #179324 in Macroeconomics for Ree

Question

Use the Keynesian-cross diagram of desired demand and output to show how an exogenous fall in investment as a result of growing investor pessimism impacts on the IS curve, draw and explain

Answer 1

$$Solution$$

Exogenous fall in investment due to investor pessimism is not depend on the interest rate here, therefore nothing in the IS equation depends on the interest rate; income must adjust to ensure that the quantity of goods produced (output), Y, equals the quantity of goods demanded, C + I + G.

Thus, the IS curve is vertical at this level, as shown above. Monetary policy neither has no effect on output, because the IS curve determines Y. Monetary policy can affect only the interest rate. In contrast, fiscal policy is effective: output increases by the full amount that the IS curve shifts.