Question

In the Keynesian closed economy IS-LM model, where interest rate is plotted along the vertical axis and output is plotted along the horizontal axis, the product market schedule will be

• A. relatively steeper if the interest elasticity of investment is low
• B. relatively steeper, the higher the marginal propensity to save
• C. relatively steeper if the interest elasticity of investment is very high
• D. relatively flatter when the interest elasticity of money demand is very high

Answer 1

The Correct Option is A, B

In the Keynesian closed economy IS-LM model, the IS curve represents equilibrium in the product market where saving equals investment. The slope of the IS curve is influenced by several factors, including the interest elasticity of investment and the marginal propensity to save.

The IS curve is relatively steeper under the following conditions: 

1. Low Interest Elasticity of Investment: When the interest elasticity of investment is low, investment does not respond greatly to changes in the interest rate. Consequently, a change in the interest rate leads to a minimal change in investment. This results in the IS curve being steeper, as a larger change in interest rates is needed to achieve equilibrium when output changes.
2. High Marginal Propensity to Save: The marginal propensity to save is the fraction of additional income that is saved rather than consumed. A higher marginal propensity to save means that increases in income lead to less consumption and more saving. This reduces the multiplier effect of income changes, causing the IS curve to be steeper.

Therefore, the correct options are:

• Relatively steeper if the interest elasticity of investment is low
• Relatively steeper, the higher the marginal propensity to save