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Chapter 21: Q2 (page 569)

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 the sensitivity of investment

to the interest rate, b, from 40 to 80. What happens to the slope of the IS curve? Why

Short Answer

Expert verified

More sensitivity of Investment to interest rate leads to flatter IS curve is, & the value of multiplier is large - depicting more change in national income due to change in output.

Step by step solution

01

Basic Concept 

The IS curve is downward sloping because an increase in real interest rates leads to decrease in investment level & net exports, which decreases aggregate demand & national equilibrium output level.

02

Explanation 

An increase in investment sensitivity to interest rate implies that a change in interest rate impacts changes in investment level & net exports by more magnitude. This subsequently leads to national output also being affected by the former by a higher magnitude.

Hence finally, the sensitivity of output level to change in interest rate also increases. It makes the IS curve flatter, depicting a larger multiplier.

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Most popular questions from this chapter

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

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?

Why does equilibrium output increase as the marginal propensity to consume increases?

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?

Go to the St. Louis Federal Reserve FRED database, and find data on Personal Consumption Expenditures (PCEC), Personal Consumption Expenditures: Durable Goods (PCDG), Personal Consumption Expenditures: Nondurable Goods (PCND), and Personal Consumption Expenditures: Services (PCESV).

a. Using the most recent data, what percentage of total household expenditures is devoted to the consumption of goods (both durable and nondurable goods)? What percentage is devoted to services?

b. Given these data, which specific component of household expenditures would be most impacted by a reduction in overall household spending? Explain.
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