The reason that the income response to a fiscal expansion is generally less in the IS-LM model than it is in the Keynesian-cross model is that the Keynesian-cross model assumes that:
A) investment is not affected by the interest rate whereas in the IS-LM model fiscal expansion raises the interest rate and crowds out investment.
B) investment is not affected by the interest rate whereas in the IS-LM model fiscal expansion lowers the interest rate and crowds out investment.
C) investment is autonomous whereas in the IS-LM model fiscal expansion encourages higher investment, which raises the interest rate.
D) the price level is fixed whereas in the IS-LM model it is allowed to vary.

Question

Quizplus · Accepted Answer

The reason that the income response is less in the IS-LM model is due to the assumption that fiscal expansion raises the interest rate and crowds out investment, which is not accounted for in the Keynesian-cross model. The Keynesian-cross model assumes that investment is not affected by the interest rate, while the IS-LM model recognizes that higher interest rates discourage investment. Therefore, A is the best choice. B and C are incorrect because they reverse the impact of fiscal expansion on the interest rate and investment compared to what is assumed in the IS-LM model. D is also incorrect because the price level is allowed to vary in both models.

The Reason That the Income Response to a Fiscal Expansion