L2 IS curve

Question 1

What does balanced budget spending do in a Keynesian cross model? Ie dt/dg=1? HOLDING ASSUMPTION T DOES NOT DEPEND ON Y

Answer 1

It increases income one-for-one!
It’s not neutral because the government takes £1 away from consumer and spends it all, rather the consumer spending £c of their income (ie with them 1-c would remain unspent for the first consumer so their initial consumption is lower) So:

1/1-c > c/1-c

Question 2

How do we get from KX to IS?

Answer 2

We look at the investment curve, what does a reduction in the opportunity cost of investing in capital do to investment? Move along

That shifts planned expenditure up

That traces the IS curve, from real interest rate changes to changes in national income

Question 3

DEF: IS

Answer 3

Shows us, for any given real interest rate
The level of income
That brings the goods market into eq’m

E=A implies I=S

Question 4

What’s the most counterintuitive, interesting features of the Keynesian model?

Answer 4

Investment -generates its own-> saving

Fall in r increases investment which increases Y via shift in E in K cross some of which is saved so output continues to rise until I=S which is a contrast with the classical case of how output is fixed by factor endowments

Question 5

Shifting the IS curve

Answer 5

Anything than changes equilibrium Y without changing r, so:

Autonomous consumption Č
Investment I(r) shifts
Changes in G

Question 6

Slope of IS curve

Answer 6

1. Multiplier changes - the larger it is, the steeper the E line so we have a higher change in Y. So the IS should be flatter, because given any r we will have a higher Y (have a view from r-axis)
2. Sensitivity of investment to the real interest rate - flatter I(r) means I more sensitive for any given r so much have flatter IS

Question 7

Fiscal policy and crowding out - what is the classical vs Keynesian view?

Work from S= Y - Č - c(Y-T) -G

Y = Č + c(Y-T) + I(r) + G

So how does saving change in response to a change in G?

Answer 7

Fewer savings reduce investment, a rise in government spending reduced investment one for one, as assuming Y is a constant ie Ŷ

Keynesians assume dy/dg = 1/1-c
So subbing back in find that
ds/dg=0
Which means that if government decides to spend business can borrow as much as they wanted before