Economics
a) Explain how the effectiveness of fiscal policy is affected by the interest elasticity of demand for money and the interest elasticity of investment.
b) Explain why fiscal policy is ineffective on a vertical LM curve.
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a)This is because investment expenditure is more interest-elastic. The increase in the interest rate to OR1 reduces large private investment so that the rise in income is smaller. Thus fiscal policy is more effective, the steeper is the IS curve and is less effective in the case of the flatter IS curve
b)Fiscal policy is completely ineffective, if the LM curve is vertical. It means that the demand for money is perfectly interest inelastic. ... When the IS curve shifts upwards to IS1, only the interest rate rises from OR to OR1 and increase in government expenditure does not affect national income at all.
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