ADJ - ISLM JEOPARDY
100

President Trump has recently imposed heavy tariffs on imported goods from China and other countries. If consumer goods become more expensive because of tariffs, what effect does this have on the interest rate (r) and direction of the movement of income (GDP, y)? Remember that we are only taking (C+I+G) into consideration for GDP. Explain which (if any) of the ISLM curves shift.

  • Income: Decreases 


    • Tariffs makes goods more expensive → consumers reduce consumption 

    • Aggregate demand falls → because higher prices lowered their real purchasing power

  • Interest rates: Decreases


    • IS shift left → At every money supply level, there is less demand for money 

    • Decreased Money Demand → lower interest rates

  • IS curve: Shifts left


    • Output decreases → Less consumption, lower demand for goods/services

  • LM curve: Unchanged


    • Overall income is falling because of lower spending → but how much money people want to hold at a given income level hasn’t changed

200

The U.S government announces a large nationwide tax credit program for first time home buyers to stimulate the real estate market. To balance out the expected effect on interest rates, the government buys back $100 billion bonds. What effect does this have on the interest rate (r) and direction of the movement of income (GDP, y)? Explain which (if any) of the ISLM curves shift.

  • Income: Increases 


    • Consumption and Investment rises →  leads to a higher output

  • Interest rates: Indeterminate


    • Higher output leads to increased interest rates 

    • Money demand increases 

    • However, buying back bonds causes interest rates to fall.

  • IS curve: Shifts right 


    • GDP growth through more consumption 

    • More aggregate demand

  • LM curve: Shifts left


    • Money demand increases

300

The government does not pass an extension of Trump’s Tax Cuts and Jobs Act. This causes the tax rate to increase for households and businesses and also reinstates the individual health care mandate. Additionally the ban on personal exemption for taxes is also lifted. At the same time, the Federal Reserve decides to sell off $500 billion in treasury bonds. How does this affect the interest rate (r) and the income/output (Y)? Explain which (if any) of the ISLM curves shift.

Personal exemption: A dollar amount from an individual's income that can be deducted from taxable income. (was roughly 4k pre TCJA)

Assumptions regarding specific values can be made for this question.

Income:  Decrease because disposable income and consumption dropping and investment drops because of the higher interest rates

Interest rates: Increase because the Fed is selling bonds and reducing the money supply.

IS →The IS curve shifts to the left due decreased output and mandatory healthcare having a larger impact and not cancelled out by the reinstatement of personal exemption. 

LM→ Shifts left because the money supply shrinks when bonds are sold

400

President Trump proposes an economic plan where he would:

  1. Cut taxes big time for businesses and individuals to help with activity in the private sector

  2. Slash federal government spending to reduce the size of the government

What effect does this have on the interest rate (r) and direction of the movement of income (GDP, y)? Explain which (if any) of the ISLM curves shift.

Answer:

  • Income: Indeterminate 


    • Less taxes → Investment would increase ->  more GDP growth 

    • Government spending decreases -> less GDP growth 

    • Opposite effects—Without known values, the direction cannot be determined

  • Interest rates: Indeterminate


    • Interest rate is dependent on the GDP in this scenario. Since the direction of movement of income is not known, the interest rate shift cannot be determined either

  • IS curve: Indeterminate


    • Because the GDP direction is unknown, the IS curve shift (if any) is also unknown.

  • LM curve: No Shift


    • LM Curve wouldn’t shift because there's no effect on money market

500

A potential widespread pandemic, similar to COVID but more deadly is panned to spread in the next year and lead to potential extinction. The government sells bonds out to increase money supply in desperation of receiving finances to fund new technology for vaccines. People start buying houses in seek of more isolation. The real estate market explodes alongside aggregate demand. What effect does this have on interest rates, income and the IS LM graphs?


Income rises

  • Investment/consumption would go up -> GDP

  • Government spending increases  

Interest rates rise

  • Aggregate demand & money demand would go up and increase rates

  • GDP growth leads to higher interest rates 

IS curve shifts right 

  • From higher aggregate demand / real estate boom

  • Higher investment/consumption and GDP growth  

LM curve shifts left 

  • Because selling government bonds sucks money out of the system, money supply decreases and money demand rises



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