Let us assume a closed economy with government expenditure (Go), household expenditure (Co) are autonomous and investment as a function of interest rate. For simplicity, let us say interest rate increases from R1, to R2.
a) Use a well labelled graph to show the relationship between investment and interest rate.
b, Draw the Keynesian cross when interest rate increases from 12, to 122 while government expenditure (Go) and household expenditure (Co) remain constant
C, user answers in part a) and b) to derive IS curve.
d) Show the effect of contractionary fiscal policy on equilibrium national income and equilibrium interest rate.