Question

Explain the impact of expansionary fiscal policy on IS curve.

Answer 1

consider the interest rate versus income graph below.

An expansionary fiscal policy leads to shift in the IS curve from IS to IS¹ due to increase in government expenditure or reduction in taxes.

The above figure illustrates fiscal policy using IS & LM curves. An increase in government expenditure or reduction in taxes shifts IS curve upwards to IS which from Y to Y¹. The rise in the national income increases the demand for money which raises interest rates from R to R¹.

Effect of change in govt expenditure expenditure is more than change in taxation.