2. Analyzing macroeconomic events with the IS curve. Consider the following even
ID: 1199872 • Letter: 2
Question
2. Analyzing macroeconomic events with the IS curve. Consider the following events in the macroeconomy. Show how to think about them using the IS curve (be detail and specific about what changes in the IS model), and explain how and why GDP is affected in the short run. You must explain graphically as well as in words. (6 points)
(a) U.S. consumers develop an infatuation with all things made in New Zealand and sharply increase their imports from that country.
(b) The government offers a temporary investment tax credit: for each dollar of investment that firms undertake, they get a credit that reduces the taxes they pay on corporate income.
Explanation / Answer
This feeling will reduce the consumer goods being made in the US. IS curve will thus shift to left. The bank shout cut Mp until Y is back to zero level. A temporary investment tax credit will increase the number of current projects, since firms will invest in projects that they otherwise might have delayed. Firms may also initiate some marginal projects that were unprofitable under previous conditions. Therefore the level of investment in the year that the tax credit is imposed will increase. Since so many projects are undertaken during the current year, fewer projects will be undertaken the following year, when the tax credit is no longer in effect. Thus the level of investment in the second year will be lower than it would have been otherwise
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