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Chapter 21: Q10 (page 566)

If a change in the real interest rate has no effect on planned investment spending or net exports, what does this imply about the slope of the IS curve ?

Short Answer

Expert verified

The IS curve is vertical & parallel to Y axis, having slope = 0

Step by step solution

01

Basic Concept 

IS curve denotes combination of interest rate & income, at which goods market is at equilibrium. It is usually a downward sloping curve showing inverse relationship between interest rate & income for output of goods equilibrium.

As increase in interest rate leads to decrease in investment expenditure & net exports, which subsequently decreases aggregate Demand & equilibrium output (& vice versa also)

02

Detail Explanation 

If interest rate doesn't effect investment expenditure & net exports, it doesn't effect aggregate demand & finally equilibrium output also.

So, in this case there is no relationship between interest rate & output level, & the former doesn't effect latter.

Hence, the curve is vertical & parallel to Y axis with 0 slope, showing constant output level at various interest rate levels.

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Most popular questions from this chapter

In each of the following cases, determine whether the IS curve shifts to the right or left, does not shift, or is indeterminate in the direction of shift.

a. The real interest rate rises.

b. The marginal propensity to consume declines.

c. Financial frictions increase.

d. Autonomous consumption decreases.

e. Both taxes and government spending decrease by the same amount.

f. The sensitivity of net exports to changes in the real interest rate decreases.

g. The government provides tax incentives for research and development programs for firms.

If firms suddenly become more optimistic about the profitability of investment and planned investment spending rises by \(100 billion, while consumers become

more pessimistic and autonomous consumer spending falls by \)100 billion, what happens to aggregate output?

If households and firms believe the economy will be in a recession in the future, will this necessarily cause a recession, or have any impact on output at all?

If the marginal propensity to consume is 0.75, by how much would government spending have to rise to increase output by \(1,000 billion? By how much would taxes need to decrease to increase output by \)1,000 billion?

Assume that autonomous consumption is \(1,625 billion and disposable income is \)11,500 billion. Calculate consumption expenditure if an increase of \(1,000 in

disposable income leads to an increase of \)750 in consumption expenditure
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