CHAPTER 11 Aggregate Demand II: Applying the IS-LM Model | 369 fiscal policy shifts the IS curve to the left, lowers the interest rate and income, and shifts the aggregate demand curve to the left. Expansionary monetary policy shifts the LM curve downward. This shift in the LM curve lowers the interest rate and raises income. The increase in income represents a rightward shift of the aggregate demand curve Similarly, contractionary monetary policy shifts the LM curve upward, raises the interest rate, lowers income, and shifts the aggregate demand curve to the left. KEY CONCEPTS Monetary transmission Pigou effect Debt-deflation theory mechanism QUESTIONS FOR REVIEW 1. Explain why the aggregate demand curve slopes 3. What is the impact of a decrease in the money downward. supply on the interest rate, income, consumption, 2. What is the impact of an increase in taxes on and investment? the interest rate, income, consumption, and 4. Describe the possible effects of falling prices on investment? equilibrium income. PROBLEMS AND APPLICATIONS 1. According to the IS-LM model, what happens In each case, explain what the central bank in the short run to the interest rate, income, should do to keep income at its initial level. consumption, and investment under the follow- ing circumstances? a. After the invention of a new high-speed computer chip, many firms decide to upgrade a. The central bank increases the money their computer systems. supply. b. A wave of credit-card fraud increases the fre- b. The government increases government quency with which people make transactions purchases. in cash. c. The government increases taxes c. A best-seller entitled Retire Rich convinces d. The government increases government the public to increase the percentage of their purchases and taxes by equal amounts. income devoted to saving. 2. Use the IS-LM model to predict the effects of 3. Consider the economy of Hicksonia. each of the following shocks on income, the a. The consumption function is given by interest rate, consumption, and investment. C = 200 + 0.75(Y - T)