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Given the investment function, I = f - hr, as the interest sensitivity of investment falls, that is as h falls, the IS curve gets A
Given the investment function, I = f - hr, as the interest sensitivity of investment falls, that is as h falls, the IS curve gets A. flatter but shifts more when government spending increases B. steeper but shifts more when government spending increases C. flatter but shifts less when government spending increases D. steeper but shifts less when government spending increases E. none of the other answers is correct
Expert Solution
ANSWER: D. steeper but shifts less when government spending increases.
IS curve represents the relationship between interest rate and output level where the goods market is in equilibrium, which means aggregate demand equals national product. It is represented by the equation;
I = f - hr
where, I = Investment
f = Autonomous investment
r = interest rate
h = Interest sensitivity factor
As Interest sensitivity of investment i.e h falls it means that investment will be low sensitive to the interest rate. Which means when interest rate falls it will cause very small increase in output level. Hence the IS curve will be steeper.
As government spending increases, it means that IS curve will shift rightwards as the interest sensitivity of investment is low, the shift in IS curve will also be less. So, the curve will shift less as government spending increases.
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