**All work and graphs must be shown** Analyzing macroeconomic events with the IS

Question

**All work and graphs must be shown**

Analyzing macroeconomic events with the IS curve (II): Consider the following changes in the macroeconomy. Show how to think about them using the IS curve, and explain how and why GDP is affected in the short run.

a) The government offers a temporary investment tax credit: for each dollar of investment that firms undertake, they recieve a credit that reduces the taxes they pay on corporate income.

b) A booming economy in Europe this year leads to an unexpected increase in the demand by European consumers for U.S. goods

c) U.S. consumers develop an infatuation with all things made in New Zealand and sharply increase their imports from that country.

d) A housing bubble bursts, so that housing prices fall by 20% and new home sales drop sharply.

Explanation / Answer

a) This investment tax credit will lead to a surge in the investment demand in liu of the benefits for the firms from such a scheme. More and more firms will undertake investments leading to an increase in the total output of the country and hence the GDP.

Speaking from and IS curve prespective the curve will shift towards the right thus increasing the overall level of output of the country. In the graph you can just make one IS LM curve , shift the IS curve towards the right to have a new equilibrium.

b) The increase in the demand for US goods will lead to an increase in the capital inflow for the country , the exports will increase and thereby increasing the GDP of the country. Again the IS curve shifts towards the right... Also in this case the exchenge rate will also be affected. As the demand for dollar will increase there is a likelihood of appreciation of dollar.

c) This is going to increase the imports of the country and at the same time reduce domestic cosnumption. Both the factors are not good for US. Increasing imports will lead to trade deficit , depreciating the currency as well, Besides the decrease in domestic consumption due to decreasing local demand will add to further pressures on the GDP... The IS cureve will shoft towards the left reducing the overall output of the economy

d) This would have a devastating affect on the economy. Though the prices of the houses will fall sharply increasing the affordability of the houses but the confidence of the people in real estate will fall sharply as seen by the sudden decrease in the new home sales. Again the revenues for the real estate sector will decrease leading to a decrease in the GDP. IS curve will again shift towards the left

Related Questions

Navigate

• Browse (All)
• Browse #
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.