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Questions › DSE › DSE 2007 › Q36
2 marksMacroeconomics › IS-LM model › Fiscal policy and crowding out in IS-LMHardabout 4 min

DSE 2007 Question 36: IS-LM model

Setup, from Q35 of the paper:

Consider the macro model: C=α0+α1YC=\alpha_{0}+\alpha_{1}YC=α0​+α1​Y, I=β0+β1Y−β2iI=\beta_{0}+\beta_{1}Y-\beta_{2}iI=β0​+β1​Y−β2​i, G=G‾G=\overline{G}G=G, with α1+β1<1\alpha_{1}+\beta_{1}<1α1​+β1​<1; money market M‾/P=γ1Y−γ2i\overline{M}/P=\gamma_{1}Y-\gamma_{2}iM/P=γ1​Y−γ2​i. If the interest rate iii increases by one unit, to maintain equilibrium in the goods market, income level Y has to decrease by

(Same model.) A unit increase in government expenditure (G) will increase the equilibrium income level (Y) by

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Plain-text version

Setup, from Q35 of the paper: Consider the macro model: C=α₀+α₁Y, I=β₀+β₁Y-β₂i, G=G̅, with α₁+β₁<1; money market M̅/P=γ₁Y-γ₂i. If the interest rate i increases by one unit, to maintain equilibrium in the goods market, income level Y has to decrease by (Same model.) A unit increase in government expenditure (G) will increase the equilibrium income level (Y) by (A) β₂/(1-(α₁+β₁)) units (B) 1/(1-(α₁+β₁)) units (C) 1/(1-(α₁+β₁)+(γ₁/γ₂)β₂) units (D) 1/(1-(α₁+β₁)+(γ₁/γ₂)α₂) units

Also written as: Setup, from Q35 of the paper: Consider the macro model: C=alpha_0+alpha_1Y, I=beta_0+beta_1Y-beta_2i, G=G_bar, with alpha_1+beta_1<1; money market M_bar/P=gamma_1Y-gamma_2i. If the interest rate i increases by one unit, to maintain equilibrium in the goods market, income level Y has to decrease by (Same model.) A unit increase in government expenditure (G) will increase the equilibrium income level (Y) by

IS-LM model has come up 137 times in 7 exams since 2004.

What this question tests

This question is on Fiscal policy and crowding out in IS-LM, part of IS-LM model in Macroeconomics.

How government spending and taxes move income and the interest rate, and how much private spending is displaced.

TestStop has 17 past-paper questions on this subtopic.

Practise IS-LM modelMore on Fiscal policy and crowding out in IS-LM

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Question from the DSE 2007 paper. Solutions are TestStop's own. Not affiliated with or endorsed by any examination authority.