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Cooleconomics.com macro-study-ISLMFE © Michael Francis Williams. All rights reserved. Cooleconomics.com Macroeconomics Study Question: IS-LM Model with Full Employment Line (Answers on subsequent pages) 1. A closed economy is humming along a full employment GDP, but Congressman Swelled Head says “Let’s cut tax rates; this will not only grow our economy in the short run but it will also stimulate long term investment and be a swell thing for generations to come. Oh, boy!” Analyze the congressman’s claim using the IS-LM model with full employment line. Assume that the economy begins at full employment GDP; then tax rates are permanently cut. (No other changes in government behavior ever occur.) a) Use an IS-LM graph to illustrate the short run and long run effects of the tax cut. b) What has happened to investment in the long run? Has it increased , declined , or stayed the same (relative to its level prior to the tax cut)? Explain your answer.
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