Start with an ISLM diagram in each question at the initial equilibrium where Y=2200 and i = 10%.
a. Suppose that households are concerned about the future and cut back on their marginal propensity to consume from 0.80 to 0.667. Try this experiment for the Ms Target case and the Interest Target Case. What happens to the multiplier? What happens to the slope of the IS curve. What happens to the equilibrium level of income or output and the interest rate? Explain this intuitively.
b. Suppose that households become less uncertain about the future and decide to hold more cash transactions demand for money. They do this reducing autonomous money demand from 30 to 20. Try this experiment for the Ms Target case and the Interest Target Case. What happens in the money market? What happens to the slope of the LM curve. What happens to the equilibrium level of income or output and the interest rate? Explain this intuitively.