Answer to Question #301316 in Macroeconomics for Wasim Alam

Question

1. Discuss, using the IS-LM model, what happens to interest rates as prices change along a given AD schedule. Explain using the diagram.

2. What is crowding out, and when would you expect it to occur? In the face of substantial crowding out, which will be more successful—fiscal or monetary policy? Explain using the diagram.

Answer 1

As prices increase, the interest rates also increase. This causes IS curve to shift from IS1 to IS2 as shown in the diagram above.

Crowding out occurs when increased government involvement in a sector of the market economy substantially affects the remainder of the market.

Fiscal policy would be most effective in case of crowding out.