Tutor profile: Adán C.
Using the IS-LM model what is the impact on interest rates if government decides to lower taxes?
A reduction in taxes will put more money into people pockets, which will lead to a rise in aggregate demand as well as savings. This will shift the IS curve up and lead to an increase in interest-rate as well as an increase in output/income per person.
You own an awesome ice cream shop and are deciding if you should close over the winter or keep it open. The building cost you $50,000, and it costs you 20,000 to keep the store open for a total cost of $70,000. Speaking with an advisor reveals your revenue during the winter will only reach $30,000 total. Should you stay open, or should you close down?
The $50,000 spent on the building is non-recoverable as you had to spend it to make it. Thus the only consideration is comparing the $20,000 variable cost to maintain the building to the $30,000 revenue. If you close: You lose the $50,000, you do not spend the $20,000 maintenance cost, but also receive no revenue. You end up losing $50,000 as a bad investment. If you stay open: You lose the $50,000 AND must spend the $20,000 maintenance cost. Meaning you are spending $70,000. However you earn $30,000 in revenue. Your overall loss is $40,000. If you stay open you may not have made any profit from your business venture, but you also minimize losses by staying open. Rule: As long as revenue is higher than average variable cost, a business should remain open, even if not having made a profit to minimize losses.
Suppose you are the chair of the Federal Reserve and are deciding to increase the required reserve ratio, and reduce the discount rate. What is the result of each of these policies and what is the overall effect this will have on the money supply?
Increasing the required reserve ratio will mean banks are required to hold a greater share of their assets in reserves rather than loaning them out which decreases money supply growth. Meanwhile decreasing the discount rate lowers that interest that banks have to pay to borrow money from the Fed, leading to an increase in the money supply growth. Given that we do not know by how much the reserve ratio or the discount rate is changing, we do not know whether the money supply will increase, decrease, or remain the same.
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