Describe how (if at all) the IS curve, MP curve, and AD curve are affected in th

Question

Describe how (if at all) the IS curve, MP curve, and AD curve are affected in the following situation:

There is an increase in taxes comma and an autonomous easing of monetary policy.There is an increase in taxes, and an autonomous easing of monetary policy.

A.

There is a movement along the MP and IS curves comma and the AD curve does not shift.There is a movement along the MP and IS curves, and the AD curve does not shift.

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B.

The IS curve shifts to the left comma and the MP and AD curves shift to the right.The IS curve shifts to the left, and the MP and AD curves shift to the right.

C.

The IS curve shifts to the left and the economy moves along the IS curve comma the MP curve shifts down comma and the netThe IS curve shifts to the left and the economy moves along the IS curve, the MP curve shifts down, and the net

effect on the AD curve cannot be definitely determined.effect on the AD curve cannot be definitely determined.

D.

The IS curve shifts to the right comma the MP curve shifts to the left and there is a movement along it comma and the AD curveThe IS curve shifts to the right, the MP curve shifts to the left and there is a movement along it, and the AD curve

does not shift.does not shift.

E.

The IS curve shifts to the right comma the AD curve is not affected comma and the slope of the MP curve becomes flatter.The IS curve shifts to the right, the AD curve is not affected, and the slope of the MP curve becomes flatter.

Explanation / Answer

If there is an increase in taxes, and an autonomous easing of monetary policy then

The IS curve shifts to the left and the economy moves along the IS curve, the MP curve shifts down, and the net effect on the AD curve cannot be definitely.

This is because an increase in taxes is an example of contractionary fiscal policy which will shift the IS curve to the left and due to easing in monetary policy(i.e., expansionary monetary policy) will lead to a downward shift of MP curve. But the effect on AD curve is not determined because, due to a reduction in taxes AD curve will shift to the left that means AD will decreases and due to easing in monetary policy that means a increases in money supply will increase the AD which will shift the AD curve to the right. So it cannot be determined how much change happens there.

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