a.) With the increase in government spending, which is a component of autonomous spending in the economy, the IS curve shifts to the right from IS to IS'. The equilibrium point shifts from point a to point b. The effect of this policy alone would be to increase the rate of interest from I to i* and the real level of output from Y to Y'. For a given supply of money, there is now a greater transaction demand for money, putting upward pressure on interest rates. Moreover, with the succeeding rounds of increased spending in the economy owing to the multiplier effect, investment spending will be stimulated, which places further upward pressure on interest rates.

With the simultaneous decrease in the money supply, the LM curve shifts upward to the left from LM to LM'. This tends to increase interest rates since the interest-sensitive components of money demand must contract enough so that money demand equals the new smaller money supply. As drawn in the diagram, when the effects of both the fiscal policy and the monetary policy change are taken into account, the new equilibrium moves from point a to point c, with Y unchanged and I increased to I'. While interest rates will definitely increase, it is uncertain what the final combined effect on Y will be. It depends on the relative magnitudes of the two policy changes. For example a third LM curve is drawn in the diagram that actually results in a decrease in real output from the original position to Y. However, the final resting point for Y could be an increase, a decrease or no change.

(b.) We do not know with certainty what the final effect of the policy mix will be on investment. The increase in interest rates from the monetary contraction will increase firms' costs of borrowing to make investment expenditures, which will tend to reduce investment expenditures. However, the increase in government expenditures will have two opposing effects on investment. One effect is the crowding out effect. The increase in government expenditures and the resulting upward influence that has on interest rates will tend to crowd out investment expenditures. On the other hand the increased general activity in the economy through the multiplier effect will tend to increase investment as new profitable projects emerge. The overall combined effect on investment will depend on the relative strengths of the different forces affecting it. The greater the slack in the economy at the time of the policy changes, the greater the likelihood that investment might, on balance, increase. If, on the other hand, the economy is at or near full employment, investment would most likely decrease.