Question

In each of the following cases, determine whether the IS curve shifts to the right or left, does not shift, or is indeterminate in the direction of shift.

a. The real interest rate rises.

b. The marginal propensity to consume declines.

c. Financial frictions increase.

d. Autonomous consumption decreases.

e. Both taxes and government spending decrease by the same amount.

f. The sensitivity of net exports to changes in the real interest rate decreases.

g. The government provides tax incentives for research and development programs for firms.

Short answer

1. No shift (Only movement) ; 2. No shift (Only rotation) ; 3. Leftward Shift ; 4. Leftward Shift ; 5. No shift ; 6. No shift (Only rotation) ; 7. Rightward Shift

Step-by-step solution

Step 1. Introduction

IS ie Investment Savings curve shows all the points of real interest rate & output, where goods market is at equilibrium.

There is movement along the curve itself due to change in real interest rates. The curve shifts due to change in autonomous variables of aggregate demand - ie autonomous consumption, investment, government spending or taxes, net exports, or miscellaneous frictional factors.

Explanation 

1. As mentioned, rise in real interest rate just leads to upward & leftward movement along the IS curve, where output decreases.
2. Increase in MPC implies that MPS decreases. It leads to change in slope of IS curve & it becomes steeper, but it doesn't shift.
3. Financial frictions decreases the equilibrium output & shifts the IS curve leftwards.
4. Autonomous Consumption decrease implies that Aggregate Demand & hence equilibrium output decreases. So, the IS curve shifts leftwards
5. Both taxes & government spending increase by same amount implies that net change in government expenditure is 0. So, the AD & equilibrium output remain same (based on the assumption that investment & tax multipliers are same). This implies that IS curve also remains unchanged.
6. Sensitivity of net exports to changes in the real interest rate decreases - just leads to change in slope of IS curve, doesn't shift it.
7. Government provides tax incentive to firms for research & development leads to increase in autonomous investment & increase AD, equilibrium output. So, it shifts the IS curve rightwards.