Assume that C c0 c1 Y T Suppose that taxes increase and money supply increases in such a way that ou...........

Economics- Phase (I & II) IS-LM

Assume that C = c0 + c1(Y-T). Suppose that taxes increase and money supply increases in such a way that output is constant in equilibrium (assume c1<1). These policy changes will produce

An increase in investment and a decrease in private consumption

An increase in investment and a decrease in government spending.

An increase in investment and an increase in private saving.

A decrease in investment and an increase in public saving.

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Explanation:

In equilibrium, Y is constant and i decreases (IS moves to the left and LM shifts down). Recall that investment, given by I(i,Y), depends negatively on the interest rate. So, as the interest rate decreases, investment increases. Also, we know that: C=c0+ c1(Y-T), and private saving is given by Y-T-C = (1- c1)(Y-T)- c0. Therefore, because T increases, private consumption and private saving both decrease. (G is constant, T-G increases.) So, B) is incorrect because government spending is constant; C) is incorrect because private saving decreases; and D) is incorrect because investment increases and public saving decreases