IS LM JNU 2011 Q14

[Rohini]

In the standard IS LM framework, an equal and simultaneous reduction in G and t will cause
a) an inc in investment
b) no change in output
c) reduction in output
d) inc in int rate


i am confused between b and c

[AJ]

I think it's (c) .. Reduction in output.. (by an amount equal to reduction in G or t)

[aastha]

it should be c . .

[divyas]

i think it shud be b)

@aastha
if its c then it implies that their is a fall in the interest rate also==>investment increases ==> option a) cud also b true
please correct me if m wrong...

[AJ]

A dec. in G and T by same amount..will shift the IS curve backward by that amount...
so, there is a decrease in output..(at each level of r)

for option b.. no change in output.. LM has to be vertical.. which means r decreases even more..
i.e. investment still increases...

[kratika]

i think it will be option c because a reduction in G will have a direct effect on reducing output whereas a reduction in t will only increase output by MPC times change in income due to change in tax...so the overall effect should be negative

[lovekesh]

I don't think it's c coz i know it's c :P

It's Balanced Budget Multiplier.