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TUTORIAL 8.3 ECO531
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Discuss about changes on the equilibrium interest rate and output using IS-LM Model. How interest rate and output is determined, and the changes on IS-LM based on different situations.
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Tutorial 8.2 ISLM1. Dec 2019 Question 5
(b) Using the IS-LM model, analyse the changes on the equilibrium interest rate and output when
there is an increase in consumer spending.
Answer: If autonomous spending
increases, then the IS curve shifts out.
The output level of the economy will
increase. Interest rates rise as we
move along the LM curve, ensuring
money market equilibrium. One
source of variations in autonomous
spending is fiscal policy. Autonomous
spending includes government
spending (G). Therefore, an increase in
G leads to an increase in output and
interest rates
2. June 2019 Question 5
(d) Briefly explain using the IS-LM diagram, how interest rate and output is determined.
Answer: The basis of the IS-LM model is an
analysis of the money market and an
analysis of the goods market, which
together determine the equilibrium levels
of interest rates and output in the
economy, given prices. The model finds
combinations of interest rates and output
(GDP) such that the money market is in
equilibrium. This creates the LM curve.
The model also finds combinations of
interest rates and output such that the
goods market is in equilibrium. This
creates the IS curve. The equilibrium is the
interest rate and output combination that
is on both the IS and the LM curves.
(e) Using the IS-LM model, analyse the changes on the real interest rate and output when the money
supply is declining.
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