2 Experiments with the IS curve The end of Chapter 11 has some nice real-world examples that relate to the IS curve. Remember what we did in class. Aggregate demand at time can be written as K=Cr+I!+GI+NX!. We introduced a model of a utility-maximizing household that lead us to conclude that consumption demand C} is a decreasing function of the real interest rate K, and a model of a profit-maximizing firm which lead to the conclusion that investment demand [ is a decreasing function of the real interest rate Ry as well. We then concluded that output ; will also be a decreasing function of R, Yi=ao - bk, where ay and by are positive coefficients. We also rewrote the equation in terms of deviations from long-term levels: } - Yi=a-blR - R) where a and b are different positive coefficients. We discussed the role of individual parameters in the consumption demand and in- vestment demand functions (these included the time preference coefficient 5 or the TFP parameter A). Now, you are asked to think more broadly about other economic experiments. Analyze the following changes to the macroeconomy through the prism of the IS curve and decide their impact on aggregate demand (and thus on the short-run output). Question 2.1 The government offers a temporary investment tax credit: For each dollar of investment that firms undertake, they receive a credit that reduces the taxes they pay on corporate income. When answering the question, remind yourself of the role of the tax on capital 75 from the problem from the midterm exam. = Question 2.2 A booming economy in Europe this year leads to an unexpected increase in the demand by European consumers for U.S. goods. n Question 2.3 U.5. consumers become fascinated with all things made in New Zealand and sharply increase their imports from that country. Question 2.4 A housing bubble bursts, so that housing prices fall by 20% and new home sales drop sharply. n Question 2.5 In at least some of the above examples, explain graphically how the central bank can use monetary policy (here, the choice of the real interest rate) in order to offset the impact of each of the changes on output. @