MS r is unchanged and Y.MS Y Monetary policy is most effective (has a largest effect on Y) when investment is completely interest-elastic.Y2Since the I is completely interest elastic, a large drop in interest rate has a largerst effect on I and therefore, on Y.

Fiscal Policy Effectiveness & the Slope of the IS Curve(a) Interest-elastic investmentr1LMIS0IS1E’ErY0Y1Yr0Suppose that G(expansionary FP)GIS curve shift to the right (from IS0to IS1)Y(from Y0to Y1)r(from r0to r1) Final equilibrium: r1, Y1Conclusion: G YFiscal policy is less effective (has a smaller effect on Y) investment is interest-elastic.Since the I is interest elastic, an increase in interest rate causes a larger C-O effect. As a result, FP is less effective (only a small increase in Y).Y2D

Fiscal Policy Effectiveness & the Slope of the IS Curve(b) Interest-inelastic investmentr1LMIS0IS1E’ErY1Y0Yr0GIS curve shift to the right (from IS0to IS1)Y(from Y0to Y1)r(from r0to r1) Final equilibrium: r1, Y1Conclusion: G YConclusion: G Y

Y2D

Y

Y

Fiscal Policy Effectiveness & the Slope of the IS Curve(d) Completely Interest-elastic investmentLMIS0= IS1ErY0 = Y1Yr0GIS curve shift to the right (from IS0to IS1)Final equilibrium: r0, Y0Conclusion: G Y unchangedConclusion: G Y unchangedFiscal policy is most ineffective (has no effect on Y) when investment is completely interest-elastic.Since the I is completely interest elastic, an increase in interest rate has a complete C-O effect. As a result, FP is not effective (has no effect on Y).

Monetary Policy Effectiveness & the Slope of the LM Curve (a) Interest-inelastic money demandr1LM1IS0LM0E’ErY0Y1Yr0Suppose that MS(expansionary MP) while P unchanged.MSLM curve shifts downward.r(from r0to r1) Y(from Y0to Y1).Final equilibrium: r1, Y1Conclusion: MS rand Y.MS Y (a larger increase in Y)Monetary policy is effective (has a large effect on Y) when money demand is interest-inelastic.Since the MD is interest inelastic, a large drop in interest rate is required to reequilibrate the money market after the increase in the money stock. As a consequence, I & Y increase by a greater amount.

Monetary Policy Effectiveness & the Slope of the LM Curve (b) Interest-elastic money demandr1LM0IS0LM1E’ErY0Y1Yr0Suppose that MS(expansionary MP) while P unchanged.MSLM curve shifts downward.r(from r0to r1).Y(from Y0to Y1).