Answer to Question #311964 in Macroeconomics for captain nyagah

Question

The economy is at full employment. now the government wants to change the composition of demand towards investment and away from consumption without, however, allowing aggregate demand to go beyond full employment. what is the required policy mix? use the IS-LM diagram to show your policy proposal

Answer 1

a)

The best policy mix would be Fiscal policy since it can lead to an increase in Aggregate Demand and a rise in real Gross Domestic Product . Economic growth increase will lead to an increase in demand for workers, providing employment and reducing unemployment. The expansion in fiscal policy will raise demand for goods and services hence greater demand will lead to an increase of both output and price.

b)

The outcome of fiscal policies in the IS-LM model depends also on the interest elasticity of the transaction demand for money. This is shown in the diagram below.