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INFORMATION AND COMMUNICATIONS UNIVERSITY
SCHOOL OF HUMANITIES
Course name
Intermediate Macroeconomics 2
An assignment submitted in partial fulfillment of the requirements for
the BA Degree in Economics and Finance
Assignment No. 2
Student details
David Syamutondo
Lecturer’s Name: Mr. Joshua Mabeta
Year: 2016
Question 1
a) Effects of Stock market crash using IS-LM model
Stock market crash will result in a sudden decline of stock prices in the market and hence
affect the internal financing of the business and hamper its growth contributing to low
economic activity in the market
IS-LM Model Showing Effects of Stock Market Crash
Interest rates
LM2
LM1
r2
r1
E1
E2
IS
Y2
Y1
(Output) Y, Investment
A sudden fall in prices for stocks will reduce the investment in the economy from E1 to E2 thus
decreasing the demand for money since the interest rates increase as shown above. These will be
the effects of the stock market crash which will affect output by decreasing it from Y1 to Y2.
Monetary policy by the government can be used to resolve the stock crash problem by increasing
the money supply in the economy which will lower the interest rates from r2 to r1 in the diagram
above thus increasing the investment and the output in the economy
b) Use of fiscal and monetary policy in the economy to resolve the stock crash problem is
illustrated by the diagrams below;
In this diagram the assumption is the monetary policy used is the increase of the supply of
money in the economy which leads to lowering the interest rates thus increasing investment as
shown from the movement of the equilibrium from E1 to E2. This measure will resolve the stock
market crash by facilitating an increase in investment in the economy.
The use of fiscal policy has a negative impact on investment because as government spending
increases or tax is reduced which increases consumption, the interest rate is pushed up which
lowers the investment in the economy thus fiscal policy is not very effective in resolving a
market stock crash. The diagram below shows the effects of fiscal policy. The increase in interest
rate shifts the LM curve to the right from LM1 to LM2 and the equilibrium moves from E2 to E1
showing a crowding out effect in terms of investments
Comparing the two policies of fiscal and monetary, it is clear that monetary policy is the best
approach in resolving a stock crash and attracts investment in the economy as shown by the ISLM model diagrams
IS-LM Model Showing Effects of Fiscal Policy
Interest rates
LM2
r2
LM1
E1
E2
r1
IS
Y2
Y1
(Income) Y, Investment
Question 2
a)
(M/P)D = 2Y – 20,000i
E=C+I+G
M/P = 2,600
E = 150+0.5(2600-300)+150+0.3(2600)-10000(0.13)+300
M/P = (M/P)D = Y
E = 150+1150+150+780-1300+300
2600 = 2(2600) – 20,000i
E = 1,230
2600 = 20,000i
I = 2600/20000
I = 0.13 = 13%
P = 0.13+0 = 0.13
b) P= i+x
P = 13%+0.5% = 13.5% Cost of bank loans increase by 0.5%
E = C+I+G
E = 150+0.5(2600-300)+150+0.3(2600)-10000(0.135)+300
E = 600+1150+780-1350
E = 1,180
Question 3
When Investment is not responsive to interest rate and there are no wealth effects, the increase in
money supply as a monetary policy will not have any effect on the IS curve as output will remain
constant due to the vertical IS curve. However a fiscal policy will shift the IS curve thus
increasing output by the same change in the shift of the IS curve
Question 4
Increase in government spending increases the planned expenditure which in turn increases the
income thus causing the IS curve to shift outwards as shown below from IS1 to IS2
Increase in government expenditure will increase the planned expenditure and thus shift the
aggregate demand to the right to a new equilibrium from A to B as income increases.