Question

Using a four quadrant diagram, discuss the effect of the following on equilibrium rate (r) and income (Y). (a)An increase in money supply (b)An increase in price level

Answer 1

Answer:

It is to be noted that every equilibrium level of output is related to a particular rate of interest. Because, change in interest rate brings about a change in the level of output or income through changing the level of investment.

Output to be in equilibrium, therefore, the rate of interest must also be in equilibrium at the same time. Rate of interest is an exogenous factor in the product market as it is determined in the money market. Product market therefore seeks to find the equilibrium values of the levels of output related to different interest rates.

One interest rate is related or associated with one equilibrium level of output and the other interest rate is related to another level of output. Thus, goods market equilibrium establishes various combinations of interest rate and output. A schedule of such combinations which show equilibrium points in the goods market is known as IS schedule.

The important condition for equilibrium in the goods market is that the total expenditure must be equal to output in the economy.

Answer 2

Answer:

It should be emphasized that each output equilibrium level correlates with a certain interest rate. Because a change in the interest rate affects the amount of output or income by altering the investment level.

In order for the output to be at equilibrium, the interest rate must likewise be at equilibrium. The rate of interest, which is set on the money market, is an external component in the product market. As a result, the product market looks for output levels that are in equilibrium with respect to various interest rates.

One interest rate is connected to or associated with one equilibrium output level, whereas the second interest rate is connected to another output level. The IS schedule is a list of these combinations that illustrates the moments at which the marketplace is in equilibrium. The requirement that the total spending match the economic output is crucial for the product's market to be in an equilibrium state.

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