For simplicity, the IS model assumes that neither net exports nor net taxes vary with income. A more realistic (and complicated) model would drop such assumptions. How would the behavior of the IS curve differ in the more realistic model?

What will be an ideal response?

In a more realistic model, increases in income would result in both more imports being purchased and more taxes being paid. The purchase of imports instead of domestic output lessens the impact of expenditure changes on inventories and, thus, on equilibrium output. Shifts of the IS curve in response to changes in autonomous spending would be smaller. Taxes that rise with income reduce the size of changes in consumption spending in response to output changes, so again shifts of the IS curve are smaller. Changes in the real interest rate change expenditures, but the effect on output is reduced to the extent that imports and taxes are changing, so the more realistic IS curve is steeper than the curve in the text.

Economics

You might also like to view...

Rank the following goods from least to most elastic: school, prep school, Purebred Prep School

A) School, prep school, Purebred Prep School B) Prep School, school, Purebred Prep School C) Prep School, Purebred Prep School, School D) Purebred Prep School, Prep School, School E) None of the above.

Economics

If a cartel is unable to monitor its members and punish those firms that violate their agreement, then

A) the member firms will each act as price setters. B) the cartel will prosper in the long run. C) the market will become a monopoly. D) the cartel will fail.

Economics