ASSIGNMENT OF MACRO ECONOMICS

SUBMITTED BY : HARSHITA SARIN

YEAR – 2nd semester – 4th
ENROLLMENT NO. 1801031

SUBMITTED TO : NAZIA HASAN mam

Q1- WHAT ARE THE DIFFERENT THEORIES
OF POST KEYNESIAN ECONOMICS ?
Rational income hypothesis states that an individual’s
attitude to consumption and saving is dictated more by his
income in relation to others than by abstract standard of
living.
Relative income hypothesis has other important economic
implications. Perhaps the most obvious implication is that
consumption creates negative externalities in the society,
which are not taken into account in individual.
Relative income hypothesis is a special case of negatively
interdependent preferences according to which
individuals care about both their absolute and relative
material payoffs
Definition: The Life-cycle hypothesis was developed by
Franco Modigliani in1957. The theory states that
individuals seek to smooth consumption over the course
of a lifetime – borrowing in times of low-income and
saving during periods of high income
.
The graph shows individuals save from the age of 20 to
65.

As a student, it is rational to borrow to fund education.

Then during your working life, you pay off student loans
and begin saving for your retirement.

This saving during working life enables you to maintain

similar levels of income during your retirement.
 It suggests wealth will build up in working age, but then
fall in retirement.
Q2- WHAT ARE THE DIFFERENCE BETWEEN
BANKS AND NBFI ?
#Meaning : An NBFC is a Bank is a government
company that provides banking authorized financ providing
services without holding a bank banking services to the general
license.to people public.ial intermediary that
aims at
Incorporated under: Banking Regulation Act1949
Companies Act 1956

#Demand Deposit Not Accepted

Accepted

#Foreign Investment
Allowed up to 100% Allowed up to 74% for private
sector banks
#Payment and Settlement
system
Not a part of system. Integral part of the system.

#Maintenance of Reserve
Ratios
Not required Compulsory

#Deposit insurance facility

Not available Available

#Credit. Creation Banks create credit.

NBFC do not create credit

Transaction services
Not provided by NBFC .Provided by banks.

QUESTION PAPER SOLUTION

Q1.
A- discuss say's law .
An important element of classical economics is Say’s
Law of Markets,
after J.B. Say, a French economist who first stated the law
in a systematic form.
Briefly stated, this law means that ‘supply always creates
its own demand.’
In other words, according to J.B. Say, there cannot be
general overproduction or general unemployment on
account of the excess of supply over demand because
whatever is supplied or produced is automatically
exchanged for money.
B- why there is negative relationship between price
and demand ?
The relationship between price and demand is negative
i.e., they are inversely related. By inversely related we
mean that as the price of the
goods increase the demand of that commodity decreases
and vice versa. This because of the law of diminishing
marginal utility. According to this law, the
utility/satisfaction of the consumer goes on decreasing
with every
additional consumption of the commodity and hence, the
consumer will buy more goods only when the price
decreases. Other reasons are income effect, substitution
effect, different uses of commodity etc.

C- Explain various type of economic growth.

Ans –
Economic growth is an increase in the the production of
economicgoods and services, compared from one period
of time to another. It can bemeasured in nominal or real
(adjusted for inflation) terms. Traditionally,aggregate
economic growth is measured in terms of gross national
product
(GNP) or gross domestic product (GDP), although
alternative metrics are sometimes used.

D- Domestic territory of country discuss.

Domestic Territory of a Country:By domestic territory, a
layman means political frontiers of a country but in
national accounting it is used in a wider sense. Domestic
territory, as used in national accounting, has a special
meaning and is much bigger than the political frontiers of
a country
It includes two things:

(i) Territory within the political boundaries of a country.

(ii) All ships, aircraft, vessels owned and operated by the
resident of the country and generating income of the
country.

E- Define CRR & SLY.

Statutory Liquidity Ratio (SLR) refers to liquid assets that
the commercial banks must hold on daily basis as a
percentage of their total deposits. SLR is determined by
the central bank and is a legal requirement to be fulfilled
by the commercial banks.

Cash Reserves Ratio (CRR) refers to the proportion of

total deposits of the commercial banks which they must
have keep as cash reserves with the central bank.
The main objective of both the ratio is to ensure that
liquidity in maintained by the commercial banks all the
time.
F- What is standard of deferred payment?
Deferred payments mean those payments which are to be
made in the future. If a loan is taken today, it would be
paid back after a period of time.
The amount of loan is measured in terms of money and it
is paid back in money. A large number of credit
transactions involving huge future payments are made
daily. Money performs this function of standard for
deferred
payments because its value remains more or less stable.
G- Explain features of indifference curve.
Ans- There are four important properties of indifference
curves that
describe most of them
(1) They are downward sloping,
(2) higher indifference curves are preferred to lower ones,
(3) they cannot intersect, and (4) indifference curves are
convex

H- Explain in brief NBFI.

A non-bank financial institution (NBFI) is a financial
institution that does not have a full banking license or is
not supervised by a national or international banking
regulatory agency. NBFIs facilitate bank-related financial
services, such as investment, risk pooling, contractual
savings, and market brokering. Examples of these include
insurance firms,pawn shops, cashier's check issuers,
check cashing locations, payday lending, currency
exchanges, and micro loan organizations.

Q2. Explain the Keynes’ psychological law of

consumption. What are the determinants of
propensity to consume?

1..Keynes propounded the fundamental psychological law

of consumption
which forms the basis of the consumption function. He
wrote, “The
fundamental psychological law upon which we are
entitled to depend with
great confidence both a prior from our knowledge of
human nature and from
the detailed facts of experience, is that men are disposed
as a rule and on
the average to increase their consumption as their income
increases but not
by as much as the increase in their income.” The law
implies that there is
a tendency on the part of the people to spend on
consumption less than the
full increment of income.
Determinants of propensity to consume ::

1. Distribution of Income

The pattern of income distribution has a great influence

on the propensity
to consume. The propensity to consume is higher for
people with low income.
They spend almost everything they earn for their
subsistence. Every
additional rupee they get is used to satisfy their unfulfilled
desires. In
contrast, affluent people inspite of their extravagant
wasteful expenditure
are able to save a lot.
2. Nature and Pattern of Income Receipt

Stability in the income receipt enhances the propensity to

consume. On the
other hand, if a person is not certain about his income or
the time of
receipt, he will spend income with utmost care so as to
save for the bad
time. The method of receiving income also affects the
propensity to
consume. A number of compulsory deductions from the
salaries for
contributions to provident fund, social security schemes,
insurance, etc.,
reduce the disposable income of people for the current
consumption.
Accordingly, the propensity to consume is adversely
affected. The
propensity to save will rise in such a case.
3. Wealth

The amount of accumulated wealth has an important

influence on the
propensity to consume. The larger the wealth accumulated
by a person, the
lesser would be the utility from each successive addition
to the existing
stock of wealth on account of already acquired financial
security.
Therefor, an attempt to decrease current consumption to
add to future
wealth will diminish. Propensity to consume is, thus,
higher with greater
wealth. If people have nothing like that, they would spend
less consumption.

4. Consumer Credit
The cost and availability of the consumer credit affects
the level of
consumption expenditure on durables like automobiles,
televisions,
refrigerators, etc. The credit purchase entails interest cost,
but,
consumers still purchase more when installment credit is
available.
Installment credit induces replacement of durable
consumer goods and
discourages saving. In the absence of consumer credit or
when its cost is
very high, the demand for durable goods would decline
substantially. In
such situation, consumers will have to wait until sufficient
funds are
accumulated to purchase these goods.

5. Stock of Consumer Durables

The stock of durables with the consumers affects their
consumption
expenditure. Possession of such goods will reduce
demand. Further,
possession of these durables will increase the demand for
non-durable
goods. For example, fruits, vegetables, milk, etc., are
purchased more than
what is presently needed so as to keep the refrigerator in
full use. As a
result, the consumption expenditure is increased.

6. Availability of Goods

The availability of goods influences the level of

consumption. When the
goods are in shortage, the people are forced to save. If on
the other
hand, some new goods are introduced,
the purchase of such goods will increase the consumption
expenditure.

7. Future Expectations

If war or an emergency is expected in the near future,

people start
hoarding goods anticipation of future shortage and rising
prices.
Consequently, propensity to consume rise. On the other
hand, if prices are
expected to fall in the future, people would buy only
essential items.
Accordingly, the propensity to consume will come down.

8. Capital Gains

Capital gains or windfall gains have considerable impact

on consumption
spending. Such unexpected and sudden gains increase the
net worth of the
consumers. The American boom of late twenties created
huge windfall gains,
increasing the consumption spending. On the contrary, a
sudden and
unexpected loss would reduce the consumption.

9. Price

Price is an important determinant of demand. A

significant rise in the
price of a commodity will substantially reduce its
consumption and
vice-versa, unless the elasticity of demand for the product
is very low.

10. Fiscal Policy

Changes in government’s fiscal policy, particularly
taxation considerably
affects the consumption expenditure. For instance, a
reduction in direct
taxes will leave more disposable income with the people.
Accordingly, the
level of consumption will arise at all levels of income.
Further, a
progressive tax policy leads to even distribution of
income and hence
raises the propensity to consume. On the contrary, a rise
in the tax rates
reduces the level of consumption. Similarly, indirect taxes
on commodities
raise their price and reduce the propensity to consume.
Taxation policy is
thus, more important for consumption expenditure than
mere changes in
prices. Further more, public expenditure on welfare
programmes raises the
propensity to consume.

11. Rate of Interest

Prior to Keynes ‘ General Theory’, the rate of interest was

considered the
major determinant of saving and hence of consumption. It
was believed that
saving was directly related to the rate of interest. In other
words,
increase in the rate of interest induces savings and
discourages
consumption.

Q3. Explain the various functions of money and what

are the measures of money supply given by RBI.

To overcome the difficulties, monetary system was

introduced and is in practice till date. In this system,
goods and services are exchanged in terms of money. For
example: If Sita needs utensils again, she will simply go
to the owner and exchange the utensils in terms of money.
In this system, the double coincidence of wants is not
necessary. It is commonly used in almost each and every
part of the world. It is much easier than the barter system.

Functions of Money:

There are many functions of money and it can be used for

different
purposes. However, the functions of money are broadly
classified into three
categories. They are primary functions, secondary
functions . They are briefly described below:

Primary Functions

Under primary functions, the functions of money are

given below.
Medium of exchange:

Money is used as medium of exchange. It is used in

buying and selling of the goods and services. It makes the
exchange of goods and services efficient by facilitating
multiple exchanges of goods and services with less time
and efforts.

Measure of value:

It is another important function of money. In a barter

system, there wasn’t common measure of value so the
value of different kind of goods could not be compared
with each other. Money can be used as a measure of value
for different goods and services. Individuals find it
convenient to use the monetary units as a measuring unit.

Secondary Functions

The secondary functions of money are described below:

Store of value:

An important secondary function of money is a store of

value of any goods and services. It is a convenient form to
store wealth. Money is a medium in which people wishes
to hold the wealth. It increases the purchasing power.

Standard of deferred payments:

It is one of the important functions of money as it can be

used as standard of the deferred payments. Deferred
payments are known as those payments which are to be
made in the future. Money is used as a standard of
deferred payments because of which borrowing and
lending have become easier.

Transfer of value:
Another important function of money is transfer of value.
It helps to
transfer the value of the assets, properties and also the
income of the person to another person. It also had made
the transfer or transaction of goods and services simpler .
For example, it is easier to transfer money from
Kathmandu to Biratnagar.

In India Reserve Bank of India uses four alternative

measures of money
supply called M1, M2, M3 and M4. Among these
measures M1 is the most
commonly used measure of money supply because its
components are regarded
most liquid assets.

Q4. Distinguish between the Keynesian and the

classical Aggregate supply curves. How does the
largeopen economy differ from a small open economy?
Ans-
Two Models for Economic Growth
When economists describe economic growth, there are
two main models that
they use. One is called the Classical model, and the other
is called the Keynesian model - named after, guess who?
If you said John Maynard
Keynes, you'd be correct. While there are other variations,
these are the two
basic models. The distinctions between these two models
are important
because one model describes how the economy works in
the short-term,
while the other describes long-term economic growth.
Both of them serve as
the foundation for other topics in macroeconomics - so
the ideas that each
model are based on will surface again down the road.
Let's take a quick look
at each of them and then explore how each model
illustrates supply and
demand differently.
Differences Between the Models
Let's look at this visually on a very basic level and see
how economists illustrate the differences between these
two models representing what the
economy looks like in the short run and also in the long
run. Both models illustrate economic growth using a chart
showing the relationship between
economic output (which is real GDP) and prices. Since
the economy operates according to the laws of supply and
demand, we have two types of curves in this model, one
representing supply and the other representing demand.
Economists call this supply curve aggregate supply,
which simply means total supply. This supply represents
all the firms in the economy, including
Bob's lawn business, Margie's cake business and many
others. When you see an aggregate supply curve, just
think of all the businesses, their products and services and
all their workers - each of which earns wages.
Economists call this demand curve aggregate demand,
which means total demand in the economy. When you
hear the words aggregate demand , think
of consumer , businesses , the government and foreigners
- all of whom want
a products and services.
difference between large open economy and small
open economy
A small open economy, is an economy that participates
in international
trade, but is small enough compared to its trading partners
that its policies do
not alter world prices, interest rates, or incomes. Thus, the
countries with
small open economies are price takers. This is unlike a
large open economy,
the actions of which do affect world prices and income.
For example, if the U.S. economy is in recession then the
world economy is
likely to suffer. On the other hand, a recession in a small
open economy like
Norway will likely not impact the world economy to a
great extent.
The theory of a small open economy is used in the study
of macroeconomics
to model a price-taking economy, allowing exogenous
assumptions of the
conditions in the rest of the world.
An open economy is a type of economy where not only
domestic actors but
also entities in other countries engage in trade of products
(goods and
services). Trade can take the form of managerial
exchange, technology
transfers, and all kinds of goods and services. (However,
certain exceptions
exist that cannot be exchanged; the railway services of a
country, for
example, cannot be traded with another country to avail
the service.)It
contrasts with a closed economy in which international
trade and finance
cannot take place.The act of selling goods or services to a
foreign country is
called exporting. The act of buying goods or services
from a foreign country
is called importing. Exporting and importing are
collectively called
international trade.
Q5- Explain various objectives of monetary policy.
What are the instruments of monetary policy?
Monetary policy implies those measures designed to
ensure an efficient
operation of the economic system or set of specific
objectives through its
influence on the supply, cost and availability of money.

Objectives of Monetary Policy:

currency exchange rates.

Inflation

Monetary policies can target inflation levels. A low level

of inflation is
considered to be healthy for the economy. If inflation is
high, a
contractionary policy can address this issue.
Unemployment

Monetary policies can influence the level of

unemployment in the economy.
For example, an expansionary monetary policy generally
decreases
unemployment because the higher money supply
stimulates business activities
that lead to the expansion of the job market.

Currency exchange rates

Using its fiscal authority, a central bank can regulate the

exchange rates
between domestic and foreign currencies. For example,
the central bank may
increase the money supply by issuing more currency. In
such a case, the
domestic currency becomes cheaper relative to its foreign
counterpa having
four distinct phases: peak, trough, contraction, and
expansion.

Business cycles are identified as having four distinct

phases: peak,
trough, contraction, and expansion.

Quantitative Measures: These are the traditional measures

of monetary
control. All the quantitative methods affect the entire
credit market in
the same direction. This means their impact on all the
sectors of the
economy is uniform. But however it does not take into
consideration the
objectives of credit control. The quantitative measure
includes the
following methods:

Open Market Operations

Bank Rate or Discount Rate

Cash Reserve Ratio

Selective Credit Controls: Since the objectives of credit

control are not
served by the quantitative methods, the economists rely
on selective
control methods to fulfill the purpose. The credit
objectives may include
rationing the credit, directing the flow of credit from least
important
sectors to the most important sectors, controlling a
speculating tendency
based on the availability of bank credit. Thus, these
objectives are very
well served by the selective control methods. It includes
the following
monetary measures:

Credit Rationing

Change in Lending Margins

Moral Suasion

In addition to these measures, the central bank uses a

Liquidity Adjustment
Facility, Repo Rate, and Reverse Repo Rate, to control
and regulate the
money supply in the economy. The Repo Rate is the rate
at which commercial
banks borrow from RBI while the Reverse Repo Rate is
the opposite of Repo
rate. It is the rate at which RBI borrows from the
commercial banks against
the government securities. The RBI keeps changing these
rate at its
discretion. The Repo Rate increases the money supply
while the Reverse Repo
Rate decreases the money supply in the economy.

Q6- Discuss Business cycle and its different phases.

The term “business cycle” (or economic cycle or boom-

bust cycle)
refers to economy-wide fluctuations in production, trade,
and general
economic activity. From a conceptual perspective, the
business cycle is the
upward and downward movements of levels of GDP
(gross domestic product) and
refers to the period of expansions and contractions in the
level of
economic activities (business fluctuations) around a long-
term growth trend.

Business cycles are identified as having four distinct

phases: expansion,
peak, contraction, and trough.

An expansion is characterized by increasing employment,

economic growth,
and upward pressure on prices. A peak is the highest point
of the business
cycle, when the economy is producing at maximum
allowable output,
employment is at or above full employment, and
inflationary pressures on
prices are evident. Following a peak, the economy
typically enters into a
correction which is characterized by a contractionwhere
growth slows,
employment declines (unemployment increases), and
pricing pressures
subside. The slowing ceases at the trough and at this
point the economy
has hit a bottom from which the next phase of expansion
and contraction
will emerge.

Q7- Define and explain main functions of Central

Bank.
Ans- Central Banks, Their Functions and Role
A central bank is an independent national authority that
conducts monetary
policy, regulates banks, and provides financial services
including economic
research. Its goals are to stabilize the nation's currency,
keep unemployment
low, and prevent inflation.
Most central banks are governed by a board consisting of
its member banks.
The country's chief elected official appoints the director.
The national
legislative body approves him or her. That keeps the
central bank aligned
with the nation's long-term policy goals. At the same
time, it's free of
political influence in its day-to-day operations. The Bank
of England first
established that model. Conspiracy theories to the
contrary, that's also who
owns the U.S. Federal Reserve.
Monetary Policy
Central banks affect economic growth by controlling the
liquidity in the
financial system. They have three monetary policy tools
to achieve this goal.
First, they set a reserve requirement. It's the amount of
cash that member
banks must have on hand each night. The central bank
uses it to control how
much banks can lend.
Second, they use open market operations to buy and sell
securities from
member banks. It changes the amount of cash on hand
without changing the
reserve requirement. They used this tool during the 2008
financial crisis.
Banks bought government bonds and mortgage-backed
securities to stabilize
the banking system. The Federal Reserve added $4 trillion
to its balance sheet
with quantitative easing. It began reducing this stockpile
in October 2017.
Third, they set targets on interest rates they charge their
member banks. That
guides rates for loans, mortgages, and bonds. Raising
interest rates slows
growth, preventing inflation. That's known as
contractionary monetary
policy. Lowering rates stimulates growth, preventing or
shortening a
recession. That's called expansionary monetary policy.
The European Central
Bank lowered rates so far that they became negative.
Monetary policy is tricky. It takes about six months for
the effects to trickle
through the economy. Banks can misread economic data
as the Fed did in
2006. It thought the subprime mortgage meltdown would
only affect housing.
It waited to lower the fed funds rate. By the time the Fed
lowered rates, it was
already too late.
But if central banks stimulate the economy too much, they
can trigger
inflation. Central banks avoid inflation like the plague.
Ongoing inflation
destroys any benefits of growth. It raises prices for
consumers, increases
costs for businesses, and eats up any profits. Central
banks must work hard to
keep interest rates high enough to prevent it.
Politicians and sometimes the general public are
suspicious of central banks.
That's because they usually operate independently of
elected officials. They
often are unpopular in their attempt to heal the economy.
For example,
Federal Reserve Chairman Paul Volcker (served from
1979-1987) sent
interest rates skyrocketing. It was the only cure to
runaway inflation. Critics
lambasted him. Central bank actions are often poorly
understood, raising the
level of suspicion.
Bank Regulation
Central banks regulate their members. They require
enough reserves to cover
potential loan losses. They are responsible for ensuring
financial stability and
protecting depositors' funds.
In 2010, the Dodd-Frank Wall Street Reform Act gave
more regulatory
authority to the Fed. It created the Consumer Financial
Protection Agency.
That gave regulators the power to split up large banks, so
they don't become
"too big to fail." It eliminates loopholes for hedge funds
and mortgage
brokers. The Volcker Rule prohibits banks from owning
hedge funds. It bans
them from using investors' money to buy risky derivatives
for their own
profit.
Dodd-Frank also established the Financial Stability
Oversight Council. It
warns of risks that affect the entire financial industry. It
can also recommend
that the Federal Reserve regulate any non-bank financial
firms.
Dodd Franks keeps banks, insurance companies, and
hedge funds from
becoming too big to fail.
Provide Financial Services
Central banks serve as the bank for private banks and the
nation's
government. They process checks and lend money to their
members.
Central banks store currency in their foreign exchange
reserves. They use
these reserves to change exchange rates. They add foreign
currency, usually
the dollar or euro, to keep their own currency in
alignment.
That's called a peg, and it helps exporters keep their prices
competitive.
Central banks also regulate exchange rates as a way to
control inflation. They
buy and sell large quantities of foreign currency to affect
supply and demand.
What is an IS curve? Explain the factors which
affect its slope. How does the decrease in govt.
expenditure affects the IS curve?
Ans-
Factors Determining the Slope of the IS Curve:
It is not enough to know that the IS curve is negatively
sloped. It may be
steep or flat. The steepness of the curve is of considerable
interest to us
because it is a factor determining the relative
effectiveness of stabilisation
policies, viz., monetary and fiscal policies.
The steepness of the IS curve depends on two things:
(i) Interest elasticity of investment
(ii) MPS, i.e., the slope of saving curve.
1. Interest elasticity of investment:
If the interest elasticity of investment is high, a small drop
in r will lead to a
large increase in I and a correspondingly large increase in
Y (through the
investment multiplier).
This point is illustrated in Fig. 9.7. In part (a) when the
investment (demand)
curve is steep (I), a fall in r will increase I by only a small
amount. In part (b)
therefore, an increase in saving and, hence, income is
needed to restore
equilibrium in the commodity market.
So the IS curve in part c (IS) is steep. If the investment
curve is relatively
flat, investment will increase by a much larger in respond
to a fall in r. Thus
increase is saving and income has to be much larger than
in the first case. In
this case the IS curve will be relatively flat (such as IS’).
2. The slope of the saving curve:
The slope of the IS curve also depends on the saving
function whose slope is
MPS. The higher the MPS, the steeper is the IS curve. For
a given fall in the
interest rate, the amount by which income would have to
be increased to
restore equilibrium in the product market is smaller
(larger), the higher
(lower) the MPS.
If the MPS is relatively high, then a small increase in
income is necessary to
generate the new saving (required to support new
investment caused by a fall
in the rate of interest) than if the MPS were low.
i. Factors that Shift the IS Curve:
To analyse the causes and effects of shift of the IS curve
we have to
incorporate government expenditure and taxes in our
analysis. The IS curve
will shift if any or all of the components of autonomous
expenditure T, I and
G change.
Now the condition of product market equilibrium given
by equation (6)
becomes
I(r) + G = S (Y – T) + T … (8)
Fig. 9.8 shows the derivation of the IS curve in the three-
sector model
including the government. In part (a), investment plus
government
expenditure must be equal to I1 + G. Therefore,
equilibrium in the goods
market requires that saving plus taxes, as shown in part
(b), equal S1, + T (=
I1 + G), at the income level Y1.
Thus the combination (r1, Y1) is one point (E’) along the
IS curve in Fig.
9.8(b). Similarly, interest rate r0 will require income level
Y0 for equilibrium
in the product market (point E in Fig. 9.8c). By
proceeding this way we
derive the IS curve which is a locus of all combinations of
Y and r which
equilibrate the goods market.
The equilibrium condition given by equation (8) shows
that a change in either
G or T will shift the IS curve and disturb an initial product
market
equilibrium position. In addition, any autonomous
(income-independent)
change which shifts the investment function will shift the
IS curve. It may be
noted that, in general all the factors that determine
autonomous expenditures
in the SKM will shift the IS curve.
The decrease in govt. expenditure affects the IS curve
If government spending increases to G, in Fig. 6.9(a) the
combined
investment plus government spending curve shifts out to
the right from I0 +
G0 to I0 + G. At a fixed interest rate r0 investment will
remain unchanged,
and I0 + G, is greater than I0 + G0 by ΔG = G1 – G0).
In order to maintain equilibrium (given by the condition I
+ G = S + T), with
a fixed level of taxes, saving has to rise from S0 to S1,
which requires income
to rise from K0 to K, in part (b).
At interest rate r0 the equilibrium point in the product
market shifts from E to
E’. Thus an increase in G shifts the IS curve to the right
from IS0 to IS1 in
part c.
The IS curve shifts by the horizontal distance E to E’
when G increases by
ΔG. The horizontal shift of the IS (e.g., distance EE1) is
that amount of the
increase in income required to generate new saving equal
to increase in
government spending.
Since the increased saving is MPS times Δ Y, the required
increase in Δ Y
(the horizontal shift of the IS curve) will be AG = AS = (1
– b) Δ Y. So the
amount of such shift of the IS curve per unit increase in G
is [1/(1 – b)], the
autonomous expenditure multiplier. In terms of Fig. 9.9
EE’ = ΔY = Y1– Y0 = ΔG (1/1 – b) … (9)
r and therefore I remaining constant. Here the multiplier
effect is present due
to induced increase in consumption caused by rising
government spending,
with investment remaining fixed.
i. Autonomous Change in Investment:
An increase in MEC caused by a favourable shift in
expectations about the
future profitability of investment projects increases
investment demand
corresponding to each interest rate. As a result the I(r)
curve shifts to the right
and, hence, the combined I + G curve to the right in Fig.
2(a).
This rightward shift of the I(r) curve, by the amount of the
autonomous
increase in investment, has exactly the same effect on the
IS curve as an
equal increase in G, as shown in Fig.2(c). Each type of
change (an increase in
I or G) shifts the I + G curve and this shift, in turn, shifts
the IS curve to the
right the autonomous expenditure multiplier [1/(1 – b)]
times the increase in
G, or increase in I.

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