The IS curve describes short-run movements in an economy via which of the follow

Question

The IS curve describes short-run movements in an economy via which of the following? a. Interest rate Investment Output Interest rate Investment Output Tax rate-st consumption Output Interest rate = Investment Output 1Tax rate Government expenditure b. e. Output The IS curve describes the relat a. negative; tax rate; investment b. positive; interest rate; output c. positive; tax rate; government expenditure d. negative; interest rate; output e. negative; interest rate; money supply ionship betweena and

Explanation / Answer

ANSWER:

1) THE CORRECT ANSWER IS B AND C BUT IF THERE IS ONLY 1 CHOICE THEN CHOOSE B FOR THE FOLLOWING REASONS AS WHEN THE INTEREST RATE GOES UP , THE INVESTMENT COMES DOWN DUE TO THE FACT THE BUSINESS WILL HAVE TO PAY EXTRA RETURN ON OPTAINING LOANS WHICH MEANS THAT BUSINESSES WOULD NOT EXPAND AND RATHER WAIT TILL THE TIME INTEREST RATE COME DOWN WHICH WILL LEAD TO THE OUTPUT BEING LOWER AS THE BUSINESSES WON'T BE PRODUCING ENOUGH AS THEY WON'T HAVE ANY REASON TO PRODUCE DUE TO LESS RETURNS AND REASON FOR C IS  BECAUSE WHEN TAX RATE INCREASES THE CONSUMPTION WILL GO DOWN DUE TO THE FACT THAT PEOPLE WILL HAVE LESS MONEY TO SPEND AND THEY WOULD RATHER SAVE THE MONEY THEY WERE SAVING PRIOR TO THE INCREASE IN TAX RATES AND HENCE THE CONSUMPTION WILL COME DOWN AND WHICH LEAD TOWARDS LESS PRODUCTION AND ULTIMATELY TOWARDS LESS OUTPUT BEING PRODUCED.

A AND D CANNOT BE THE RIGHT ANSWER BECAUSE WHEN THE INTEREST RATE ARE HIGHER , THE INVESTMENT GOES DOWN AND NOT UP DUE TO THE FACT THAT HIGHER INTEREST RATE MEANS LESS RETURN ON THE PROFIT AS HIGHER INTEREST RATES WOULD EAT INTO THE PROFIT OF THE INVESTOR AND HENCE HE WOULD LESS LIKELY TO INVEST WHEN THE INTEREST RATES ARE HIGHER AND HENCE OPTION A AND D ARE WRONG.

OPTION E IS WRONG BECAUSE WHEN TAX RATE INCREASES GOVERNMENT'S SOURCE OF INCOME INCREASES AND NOT NECESSARILY THE GOVERNMENT EXPENDITURE AS THE GOVERNMENT MIGHT SAVE THAT EXTRA INCOME EARNED FROM THE INCREASE IN THE TAX RATE AND THEREFORE ONE CANNOT SURE AND ALSO 1 MORE THING THAT EVEN IF THE GOVERNMENT IS SPENDING THAT IS THE GOVERNMENT SPENDING IS INCREASING IT MEANS THAT THE GOVERNMENT IS MERELY REDISTRIBUTING THE INCOME FROM ONE SECTION OF SOCIETY TO ANOTHER ONE AND THEREFORE THE OUTPUT CANNOT INCREASE OVERALL AS THE OUTPUT WILL INCREASE IN SOME THINGS BUT DECREASE IN ANOTHER THINGS.

2) THE CORRECT ANSWER IS D BECAUSE THE CURVE TELLS THE RELATION BETWEEN INTEREST RATE AND THE OUTPUT PRODUCED AS THE INVESTMENT IS ALWAYS BASED ON THE INTEREST RATES ISSUED BY THE GOVERNMENT WHICH DEFINES THE GOVERNMENT POLICY AND THE OUTPUT PRODUCED WHICH WILL DEPEND UPON THE INTEREST RATES AS IF THEY ARE HIGHER THE OUTPUT WILL BE LESS AND VICE VERSA AND THE RELATION IS ALWAYS INVERSELY PROPOTIONAL OR NEGATIVE.

OPTION A CANNOT BE RIGHT BECAUSE THE IS CURVE IS THE INVESTMENT SAVING RELATIONSHIP WHICH IS DECIDED BY THE INTEREST RATES AND NOT THE TAX RATES .

OPTION B AND C CANNOT BE RIGHT BECAUSE THE INVEST SAVING CURVE ALWAYS HAS A INVERSELY PROPOTIONALOR NEGTIVE RELATIONSHIP BECAUSE IF THE INVESTMENT IS MORE WHICH WILL BE DUE TO THE LESS INTEREST RATES WHICH WILL INCREASE THE OUTPUT LEADING TOWARDS MORE PURCHASE AND LESS SAVING AND HENCE THE NEGATIVE RELATIONSHIP AND NOT THE POSITIVE.

OPTION E IS NOT RIGHT BECAUSE IS CURVE SHOWS THEW RELATION BETWEEN INTEREST RATE AND OUTPUT AND NOT ON INTEREST RATE AND MONEY SUPPLY BECAUSE MONEY SUPPLY RELATIONSHIP IS SHOWN BY THE LM CURVE AND NOT THE IS CURVE.

  

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