Figure 4-7
-Using the information contained in the figure above, the initial equilibrium Y is 3500. If there is 500 of new fiscal stimulus and a constant money supply, Y will increase to ________ and the interest rate will ________.
A) 4000; remain constant
B) 4000; rise to 10%
C) 4500; rise to 12.5%
D) 5500; remain constant

Question

Figure 4-7 
-Using the information contained in the figure above, the initial equilibrium Y is 3500. If there is 500 of new fiscal stimulus and a constant money supply, Y will increase to ________ and the interest rate will ________.
A) 4000; remain constant 
B) 4000; rise to 10% 
C) 4500; rise to 12.5% 
D) 5500; remain constant

Quizplus · Accepted Answer

Based on the information in the figure, an increase in fiscal stimulus will shift the IS curve to the right, resulting in an increase in equilibrium output (Y) and an increase in the interest rate. Given that the money supply is constant, the LM curve does not shift, and therefore the increase in the interest rate is determined solely by the shift in the IS curve.

Using the information in the figure, we can approximate that a $500 increase in fiscal stimulus will shift the IS curve to the right by roughly 100 units (from IS1 to IS2). At the initial equilibrium Y of 3500, this would correspond to an interest rate of approximately 8.5% (as shown on the vertical axis of the figure).

With the shift in the IS curve, the new equilibrium level of output is approximately 4500 (as shown on the horizontal axis of the figure). Based on the intersection of the IS2 and LM curves at this level of output, the new equilibrium interest rate is approximately 12.5%. Therefore, the correct answer is choice C: 4500; rise to 12.5%.

Figure 4-7 -Using the Information Contained in the Figure Above, the Initial