tutorial 4 - answers - ECON205 Macroeconomic Theory and...

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ECON205, Macroeconomic Theory and Policy - Tutorial 4: Short Run Macroeconomics (III) Simone Marsiglio 1 Conceptual Questions 1. Consider the IS-LM model and represent graphically the equilibrium, discussing the effects of expan- sionary fiscal policy on equilibrium output and equilibrium interest rate. The equilibrium is represented by the point in which the IS and LM curves cross, such that goods and financial markets are simultaneously in equilibrium. Expansionary fiscal policy (increase in govern- ment spending or decrease in taxes) shifts the IS curve rightward (by increasing demand for goods at the given interest rate), leading to a higher equilibrium output and higher equilibrium interest rate. Since the interest rate increases (decreasing investment), the increase in equilibrium output is lower than what we would expect from the demand multiplier. Demand, Z Output, Y Interest rate, i 2. Consider the IS-LM model and represent graphically the equilibrium, discussing the effects of expan- sionary monetary policy on equilibrium output and equilibrium interest rate. The equilibrium is represented by the point in which the IS and LM curves cross, such that goods and financial markets are simultaneously in equilibrium. Expansionary monetary policy (increase in
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