2. Identify whether the following events lead to a shift of the curve or movemen

Question

2. Identify whether the following events lead to a shift of the curve or movement along the curve and specify its direction. A. How does an increase in interest rate affect the IS curve? B. How does a tax cut affect the aggregate demand (AD) curve? C. How does a severe natural disaster (like hurricane) affect long-run aggregate supply (LRAS) curve? D. How does a decrease in interest rate affect the planned expenditure (PE) curve? E. How does scaling back government spending affect the IS curve? F. The Fed decides to increase the required reserve ratio for banks. How does it affect the AD curve?

Explanation / Answer

A. Change in interest rate leads to movement of IS curve. Increase in interest rate leads to leftward movement of IS curve.

B. Tax cut increases disposable income of consumer and thus it increases consumption component of AD and shifts the AD curve rightwards.

C. Natural disaster adversely affect supply of commodity in the market and leads to decrease in supply of commodity in long run. This shifts LRAS curve leftwards.

D. Decrease in interest rate increases investment and shifts AE curve upwards.

E. Decrease in government spending leads to fall in G component of IS curve and shifts the IS curve leftwards.

F. Change in required reserve ratio leads to change in AS curve not AD curve.

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