Answer to Question #229371 in Macroeconomics for Katriche

Question

1.1 Define the IS curve and explain how the IS-curve is derived. Use graphs to illustrate your answer. (8 marks)

1.2 Draw a graph with the AD (aggregate demand), short run AS (aggregate supply) and long run AS curves. Assume the economy is in a state of long run equilibrium. Clearly indicate this on the graph. (5 marks)

1.3 Now consider an increase in government spending (G). Explain, verbally and graphically, the impact of the increase in G on the AD-AS model in the short run. (5 marks)

1.4 Show and explain the AS adjustment process, in other words, how output adjusts over time, from the short run to the long run (following the increase in G). [6 marks]

Answer 1

1.1

The IS curve shows set of all levels of interest rates and output at which total investment equals saving.

it emphasizes interaction between goofs and money markets.

Any point on IS curve shows intersection between saving and investment for some interest rate and income (Y,r). Any change of factors shifts the IS curve as shown.

1.2

1.3

Increase in government expenditure will increase demand for goods and services thereby shifting aggregate demand(AD) curve to the right.

1.4

In long run the increased demand for goods and services will lead to increased output thereby shifting the aggregate supply (AS) curve to the right.