Analyzing macroeconomic events with the IS curve (II):

Consider the following changes in the macroeconomy. Show how to think about them using the IS curve, and explain how and why GDP is affected in the short run.

(a) The government offers a temporary investment tax credit: for each dollar of investment that firms undertake, they receive a credit that reduces the taxes they pay on corporate income.

(b) A booming economy in Europe this year leads to an unexpected increase in the demand by European consumers for U. S. goods.

(c) U. S. consumers develop an infatuation with all things made in New Zealand and sharply increase their imports from that country.

(d) A housing bubble bursts so that housing prices fall by 20% and new home sales drop sharply.

Answer and explanation:

a)  

This investment tax credit will lead to a surge in the investment demand, because of the benefits that the firms receive from the investment tax credit. More and more firms will undertake investments leading to an increase causing the IS curve to shift to the right.  

This implies that the output and GDP will increase in the short run.  

(check image file 1 attached)

b)  

The increase in the demand for US goods will lead to an increase in the capital inflow for the country, the exports will increase, and the IS curve will shift to the right.  

This implies that the output and GDP will increase in the short run

(check the attached image file 2)

c)  

US consumers' infatuation with goods and services from New Zealand is going to increase the imports of the country. While it may also reduce the domestic consumption spending. This, however, will affect the country by shifting its IS curve to the left.  

This implies that the output and GDP will decrease in the short ran.  

(check image file 3)

d)  

Though the prices of the houses will fall sharply, increasing the affordability of the houses but the confidence of the people in real estate will be shaken. This would lead to a fall in the housing investment. This fall in investment will shift the IS curve to the left.  

This implies that the output and GDP will decrease in the short run.

check image file 4

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