Answer to Question #234345 in Macroeconomics for Nald

Question

For each of the changes in expectations in (a) through (d), determine whether there is a right or
left shift in the IS curve, the LM curve, both curves, or neither. In each case, assume that expected
current and future inflation are equal to zero and that no other exogenous variable is changing.
a) A decrease in the expected future real interest rate.
b) An increase in the current money supply.
c) An increase in expected future taxes.
d) A decrease in expected future income

Answer 1

Solution:

a.). A decrease in the expected future real interest rate will affect both the IS and LM curves.

It will lead to an increase in the money demand thus shifting the LM curve to the left.

Similarly, the IS curve will shift to the right since the expected decrease in real interest rate will stimulate investments thus increasing GDP.

 

b.). An increase in money supply will only affect the LM curve.

The increase in money supply will shift the LM curve down to the right since investment will increase resulting in lower interest rates.

 

c.). An increase in expected future taxes will only affect the IS curve:

An increase in expected future taxes will shift the IS curve to the left since taxes will effectively decrease consumption, investment, and total output.

 

d.). A decrease in expected future income will affect both the IS and LM curves.

A decrease in expected future income will shift the IS curve to the left and the equilibrium level of output, income, and employment to decrease.

Similarly, the LM curve will shift to the right since expected lower levels of income will increase the money supply.