According to the IS-LM model, when the government increases taxes and government purchases by equal amounts:
A) income, the interest rate, consumption, and investment are unchanged.
B) income and the interest rate rise, whereas consumption and investment fall.
C) income and the interest rate fall, whereas consumption and interest rise.
D) income, the interest rate, consumption, and investment all rise.

Question

Quizplus · Accepted Answer

When the government increases taxes and government purchases by equal amounts, it leads to a decrease in disposable income, which causes a fall in consumption. This leads to a leftward shift in the IS curve, causing a rise in the interest rate and a fall in income. Investment also falls due to higher interest rates. Hence, choice B is the correct answer as it correctly captures the impact of the policy on variables in the IS-LM model.

According to the IS-LM Model, When the Government Increases Taxes