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 eects 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 dierent from its original level?
(b) Analyze the eects of an increase in the government purchases 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 dierent from its original level?