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Chapter 21: Q17 (page 566)

Suppose you read that prospects for stronger future economic growth have led the dollar to strengthen and stock prices to increase.

a. What effect does the strengthened dollar have on the IS curve?

b. What effect does the increase in stock prices have on the IS curve?

c. What is the combined effect of these two events on the IS curve?

Short Answer

Expert verified

Strengthened dollar will increase IS, shift the curve rightwards. Increase in stock prices will decrease IS, shift the curve leftwards. Combined effect of both depends upon their relative magnitude.

Step by step solution

01

Introduction 

IS ie investment saving curve shows combinations of interest rates & output levels at which goods market is at equilibrium.

It is effected by level of Aggregate demand; which is further effected by Consumption, investment, net government expenditure & net exports.

02

Explanation 

  • Strengthening of dollar implies that it becomes expensive in forex markets, which leads to expensive exports & cheaper imports. So, net exports decrease & aggregate demand falls, IS curve also decreases & shifts leftwards.
  • Increase in stock prices imply that autonomous planned investment expenditure expenditure increases, due to economy being in growth stage. It leads to increase in AD & IS curve also increases, shifts rightwards.
  • Strengthening of dollar & increase in stock prices have opposite impacts of increasing & decreasing IS respectively. So, the net impact depends on their magnitude relative comparison.

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Most popular questions from this chapter

Consider an economy described by the following data:

C=\(4trillionI=\)1.5trillionG=\(3.0trillionT=\)3.0trillionNX=\(1.0trillionf=0

mpc = 0.8

d = 0.35

x = 0.15

a. Derive an expression for the IS curve.

b. Assume that the Federal Reserve controls the interest rate and sets the interest rate at r = 4. What is the equilibrium level of output?

c. Suppose that a financial crisis begins and f increases to f = 3. What will happen to equilibrium output? If the Federal Reserve can set the interest rate, then at what level should the interest rate be set to keep output from changing?

d. Suppose the financial crisis causes f to increase as indicated in part (c) and also causes planned autonomous investment to decrease to I = \)1.1 trillion. Will the change in the interest rate implemented by the Federal Reserve in part (c) be effective in stabilizing output? If not, what additional monetary or fiscal policy changes could be implemented to stabilize output at the original equilibrium output level given in part (b)?

Assuming both taxes and government spending increase by the same amount, derive an expression for the effect on equilibrium output.

Go to http://www.eurmacro.unisg.ch/Tutor/islm.html. Set the policy instruments to G = 80, t = 0.20, c = 0.75, and b = 40. Now increase government spending, G, from 80 to 160. By how much does the IS curve shift horizontally to the right? Why is the amount of shift greater than the increase in G? Now increase the marginal propensity to consume, c, from 0.75 to 0.90. In which direction does the IS curve shift, and why? By how much does it shift? Now increase the tax rate, t, from 0.20 to 0.28. In which direction does the IS curve shift, and why? By how much does it shift?

If the consumption function is C = 100 + 0.75YD, I = 200, government spending is 200, and net exports are zero, what will be the equilibrium level of output?

What will happen to aggregate output if government spending rises by 100?

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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