Answer to Question #319110 in Macroeconomics for Simran

Question

Explain graphically how fiscal expansion can be accomodated by monetary expansion through IS, LM curves.

Answer 1

in the IS-LM model, with the shift of the IS curve from IS₁ to IS₂ following the reduction in taxes, the economy moves from equilibrium point E to D and, as is evident from Fig. 20.7, rate of interest rises from r₁ to r₂ and level of income increases from Y₁ to Y₂. Income equal to LH has been wiped out because of crowding-out effect on private investment as a result of rise in interest rate.