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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

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

Inventories typically increase starting at the beginning of recessions, and begin to decline near the end of recessions. What does this say about the relationship between planned spending and aggregate output over the business cycle?

When the Federal Reserve reduces its policy interest rate, how, if at all, is the IS curve affected? Briefly explain.

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

Suppose that Dell Corporation has 20,000 computers in its warehouses on December 31, 2019, ready to be shipped to merchants (each computer is valued at

\(500). By December 31, 2020, Dell Corporation has 25,000 computers ready to be shipped, each valued at \)450.

a. Calculate Dell’s inventory on December 31, 2019.

b. Calculate Dell’s inventory investment in 2020.

c. What happens to inventory spending during the early stages of an economic recession?
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