Only need to answer 1.5-1.7 Kevnesian Cross (Goods market) and IS/MP Diagram (25
ID: 1132081 • Letter: O
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Only need to answer 1.5-1.7 Kevnesian Cross (Goods market) and IS/MP Diagram (25 points) Assume the economy behaves according to the assumptions in the Keynesian cross and IS curve. Also, assume that the marginal propensity to consume is 0.8. 1.1 Using the space below, illustrate the goods market (Keynesian cross - top panel) and IS/MP diagram (bottom panel). Be sure to carefully label the axes, curves, and initial equilibrium Point A on both diagrams. [4] 1.2 Now, suppose that the government decreases taxes by $400 in this economy. On your diagram above in 1.1 illustrate how this policy affects the goods market on your Keynesian cross diagram. Be sure to clearly indicate how much the expenditure line shifts on your diagram (include a number). Label the equilibrium Point B' and be sure to clearly label any new curves and equilibrium values. [3 1.3 Compute the change in output resulting from the policy mentioned in 1.2. [Use the appropriate multiplier]. [3]Explanation / Answer
1.5 A decrease in the taxes will increase the disposable income of the consumers and thus increase consumption expenditure of the consumers. This will increase aggregate expenditure of the consumer and thus shift the aggregate expenditure line upwards. In the IS-LM diagram, expenditure in the goods market will increase and IS curve will shift rightwards due to increase in the level of aggregate demand in the economy caused by fall in tax rate.
1.6 The rightwards shift in the aggregate expenditure and IS curve will lead to increase in output, increase in real interest rate in the economy, consumption increases with increase in disposable income and increase in rate of interest will reduce private investment level in the economy.
1.7 Yes, this policy leads to crowding out. This is because rightwards shift of the IS curve will lead to increase in interest rate in the economy which is the cost of private investment in the economy and increase in interest rate will reduce private investment in the economy and thus it leads to crowding out effect.
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