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Intermediate Economics B

Problem Set 3

1. Explain the determinants of investment in the IS-LM model. Include in your answer an explanation of how a change in each determinant affects investment.

2. When the central bank pursues contractionary monetary policy in the IS-LM model, what happens to the interest rate, output and the level of investment? Explain what happens to the position of the IS curve as the central bank pursues contractionary monetary policy.

3. Explain the impact of a tax cut on income, the interest rate and money demand in the IS-LM model. Explain what happens to the position of the LM curve as policy makers pursue expansionary fiscal policy.

4. Explain the differences between a tax cut and an increase in government spending in the context of the IS-LM model.

5. Based on your understanding of the IS-LM model, graphically illustrate and explain what effect a reduction in consumer confidence will have on output, the interest rate, and investment.

6. Explain why conventional monetary policy loses effectiveness in a liquidity trap.