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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

During and in the aftermath of the financial crisis of 2007–2009, planned investment fell substantially despite significant decreases in the real interest rate.

What factors related to the planned investment function could explain this?

Consider an economy described by the following data:

C=\(3.25trillionI=\)1.3trillionG=\(3.5trillionT=\)3.0trillionNX=-\(1.0trillionf=1

mpc = 0.75

d = 0.3

x = 0.1

a. Derive simplified expressions for the consumption function, the investment function, and the net export function.

b. Derive an expression for the IS curve.

c. If the real interest rate is r = 2, what is equilibrium output? If r = 5, what is equilibrium output?

d. Draw a graph of the IS curve showing the answers from part (c) above.

e. If government purchases increase to \)4.2 trillion, what will happen to equilibrium output at r = 2? What will happen to equilibrium output at r = 5? Show the effect of the increase in government purchases in your graph from part (d).

Calculate the value of the consumption function at each level of income in the following table if autonomous consumption = 300, taxes = 200, and mpc = 0.9.

Why do companies cut production when they find that their unplanned inventory investment is greater than zero? If they didn’t cut production, what effect would

this have on their profits? Why?

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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