Answer to Question #227139 in Macroeconomics for Natalie

Question

Draw diagram of a typical IS-LMmodel and indicate the changes in all the variables on the diagram should there be an increase in aggregate expenditure causing a shift of the IS curve to the right ( indicate the shift in the IS curve on your diagram) Indicate where macroequilibrium will be and properly label the axes on the diagram. Briefly explain what you understand such an IS-LM model is actually reflecting in terms of macroeconomics

Answer 1

When IS curve moves to the right, it causes higher interest rates and expansion in the "real" economy . i shifts to i' and y shifts y'. 

IS curve shows the combinations of interest rate and output at which the goods market is in equilibrium. 

So when any component of AD shifts the IS curve shifts outward , this increases output. So in macroeconomic terms government by effecting an component of AD can shift the IS curve. This increases consumption. But due to increase in interest rate , the investment falls. Therefore the composition of AD changes.