Answer to Question #246892 in Macroeconomics for Nishuu

Question

Consider an Economy in its medium run equilibrium. Now suppose that the government passes a stricter law against the exercise of market power leading to decline in mark-up over wages. Explain using IS-LM and AD-AS curves how it will affect price level, interest rate and output in the short run and in the medium run.

Answer 1

LM curve shows the positive relationship between interest rate and output. It means as the interest rate rises then output also rises and as the interest rate falls then output also falls.

The stricter law causes a leftward shift in the IS curve. It means IS curve decreases with the same LM curve such that both interest rate and output decrease into an economy. As the IS curve shifts leftward then the aggregate demand curve decreases such that both price level and output fall into an economy.