In the long-run ISLM model, the long-run effect of a cut in government spending is to
A)increase real output and the interest rate.
B)increase real output and not affect the interest rate.
C)not affect real output and increase the interest rate.
D)not affect real output and reduce the interest rate.

Question

Quizplus · Accepted Answer

In the long-run ISLM model, a cut in government spending leads to a decrease in aggregate demand, which initially reduces real output and the interest rate. However, in the long run, the economy returns to its potential output level due to price and wage adjustments, leaving real output unchanged. The reduced demand for money due to lower government spending leads to a lower interest rate.

In the Long-Run ISLM Model, the Long-Run Effect of a Cut