Answer to Question #229373 in Macroeconomics for Katrichie

Question

Explain why each of the following statements is true. Discuss the impact of monetary and fiscal policy in each of these special cases:

3.1 If investment does not depend on the interest rate, the IS curve is vertical. (5 marks) 3.2. If money demand does not depend on the interest rate, the LM curve is vertical. (5 marks)

3.3. Use the IS-LM diagram to describe the short-run and long-run effects of an increase in government purchases on national income, the interest rate, the price level, consumption, investment, and real money balances. (note: your answer must include a graph and explanation in words) (10 marks) 

Answer 1

3.1) When the investment never relies on interest rate, there is nothing in IS equation depending on interest rate. Income needs to adjust in ensuring quantity of produced goods are the same as the ones demanded. Monetary policy however may the production to be more than the quantity demanded.

3.2) When the demand for money never relies on interest rate, LM equation may be expressed as L(Y) = M/P. In any provided real balances level, only one income level where money is at equilibrium is found.

3.3)