Answer to Question #227248 in Macroeconomics for fatima

Question

 How does an increase in the tax rate affect the IS curve?

b.

How does the increase affect the equilibrium level of income?

c.

How does the increase affect the equilibrium interest rate? 

Answer 1

The increase in taxes shifts the IS curve. The LM curve does not shift, the economy moves along the LM curve. When taxes increase, consumption decreases, leading to a decrease in output/income. When taxes increase: Consumption goes down, leading to a decline in income. The decrease in income reduces the demand for money. Given that the supply of money is fixed, the interest rate must decrease to push up the demand for money and maintain the equilibrium. As price levels increase, money demand increases. This position is higher on the demand curve, and therefore the equilibrium interest rate is higher.