Suppose money demand depends on disposable income, so that the equation for the money demand becomes (M/P)^d = L(r, Y-T).
(a) Analyze the effects of a tax cut in an IS-LM model. How does the tax cut shift the IS curve and the LM curve? How are equilibrium interest rate and level of income different from its original level?
(b) Analyze the effects of an increase in the government purchase in an IS-LM model. How does the increase in government spending shift the IS and the LM curve? How are equilibrium interest rate and level of income different from its original level?