In explaining the 2003 bill to cut taxes, Presodent Bush is quoted as saying, \"
ID: 1186640 • Letter: I
Question
In explaining the 2003 bill to cut taxes, Presodent Bush is quoted as saying, "When people have more money, they can spend it on goods and services."
a. In the IS-LM model, will a tax cut change the money supply in the economy? Does a change in the money supply shifts the IS or the LM curve?
b. In the IS-LM model, does a tax cut shifts the IS or the LM curve? Your answer must clearly state which curve shifts
c. Based on your answer in a and b, how can you reconcile the President's statement with economics? Can you suggest how his statement could be modified to be consistent with teh IS-LM model?
Explanation / Answer
a) Tax reduction will lead to money supply increasing. Money supply affects the LM curve.
b) Tax reduction will lead to increase invemstment. IS will shift to the right.
c) IS right shift is the fundamental shift. The LM shift in a) is because the goverment wants to keep the interest rate the same. We are talking about equillibrium markets with real market and money market being in equillibrium. This is what makes answers a) and b) consistent. In short we need to change from hicks view to Keynes view:
Hicks theory: At each point on IS schedule S=I (Real market)
Keynes theory says that at each point on LM, Supply money is equal to demand for money.