1. The document compares the assumptions and equilibrium income determination of the simple Keynesian model and modern Keynesian model. 2. It then analyzes how fiscal policy actions like changes in government spending and taxes would impact equilibrium income using the Keynesian model. 3. The effectiveness of monetary and fiscal policy using the IS-LM model is discussed, noting that monetary policy is most effective when the LM curve is vertical and fiscal policy is most effective when the IS curve is steep. The relationship between the slopes of the IS and LM curves and policy effectiveness is summarized in a table.

1. GROUP 1.2
SYAHRUL FAHIMI BIN ASHAARI EEE130088
SYAFIKAH BINTI KUNHAMOO EEE130087
NUR ‘IFFAH BINTI IDRUS EEE130074
NURSYAMIRA IZZATI BINTI AZHARI EEE140096
TUTORIAL
2

2. QUESTION 1
1. Compare the simple Keynesian model and
the modern Keynesian model on how
equilibrium income is determined. What are the
assumptions of these models?

3. ASSUMPTIONS
SIMPLE KEYNESIAN MODEL MODERN KEYNESIAN MODEL
Price is fixed. Price is flexible.
Income is determined by demand
side factor only.
Income is determined by demand
side factor and supply side factor.
Aggregate supply curve is
horizontal.
Aggregate supply curve is upward
sloping
Monetary side of the economy is
excluded.
Monetary side of the economy is
included.

5. QUESTION 2

6. A) WOULD EQUILIBRIUM INCOME
CHANGE OR REMAIN THE SAME AS A
RESULT OF THESE TWO POLICY
ACTIONS?

7. (B) IF EQUILIBRIUM INCOME CHANGED,
IN WHICH DIRECTION WOULD IT MOVE,
AND BY HOW MUCH?
Δ𝒀 =
𝟏
𝟏−𝒃
ΔG Δ𝒀 =
𝟏
𝟏−𝒃
( − 𝒃) ΔT ΔG= 10 units
Δ 𝒀
Δ 𝑮
=
𝟏
𝟏−𝒃
Δ 𝒀
Δ 𝑻
=
−𝒃
𝟏−𝒃
ΔT= 10 units
Δ 𝒀
Δ 𝑮
+
Δ 𝒀
Δ 𝑻
=
𝟏
𝟏−𝒃
+
−𝒃
𝟏−𝒃
=
𝟏−𝒃
𝟏−𝒃
= 1

8. (B) IF EQUILIBRIUM INCOME CHANGED,
IN WHICH DIRECTION WOULD IT MOVE,
AND BY HOW MUCH?Assume: b = 0.5
Δ𝒀 =
𝟏
𝟏−𝒃
ΔG
𝟏
𝟏−𝒃
=
𝟏
𝟏−𝟎.𝟓
= 𝟐
Δ𝒀 = (𝟐) (𝟏𝟎)
Δ𝒀 =
−𝒃
𝟏−𝒃
ΔT
−𝒃
𝟏−𝒃
=
−𝟎.𝟓
𝟏−𝟎.𝟓
= -1
Δ𝒀 = (−1) (10)
Δ𝒀 = -10 units Δ𝒀 = 20 + (-10) = 10 units
*So equilibrium income moves same direction with increasing in government
spending and, and it increased by 10 units.

9. (C) WHAT IS THE NAME OF THE
MULTIPLIER FOR THE ABOVE
POLICY?
We call it balanced budget multiplier
Δ 𝒀
Δ 𝑮
+
Δ 𝒀
Δ 𝑻
=
𝟏
𝟏−𝒃
+
−𝒃
𝟏−𝒃
=
𝟏−𝒃
𝟏−𝒃
= 𝟏
Balanced budget multiplier gives the change in
equilibrium output that result from a 1 unit
increase or decrease in both taxes and
government spending.

10. (D) SOME ECONOMISTS AGAINST
THE ACTIVE FISCAL STABILIZATION
POLICY. WHY?
1. Active fiscal stabilizations policy effects the
economy with a substantial lag due to the political
process fiscal policy
2. The process of government negotiation, passing and
implement the fiscal policy slow down the time for
economy to recover to its equilibrium
3. Tax multiplier is smaller, the appropriate tax cut
would be larger than the required spending increase
4. Aggregate demand schedule was being pushed
above the level consistent with potential output (Yp)

11. (E) HOW TO AVOID PROBLEM IN
(D)?
1. Automatic stabilizers can be adopted to avoid
lags in active fiscal stabilization policy.
2. Automatic stabilizers are changes in fiscal
policy that stimulate aggregate demand
without policymaker having to take any
deliberate action to reduce the fluctuations of
economy.
3. Automatic stabilizers are marginal tax rates
(personal income tax, company income tax).

12. (F) IF THE GOVERNMENT WERE TO
OPERATE UNDER A STRICT POLICY AS
IN (A), WHAT IS THE EFFECT ON (E)?
If the government were to operate under a
strict balanced budget policy, the automatic
stabilizers inherent in our current system of
taxes and government spending would be
eliminated.

13. QUESTION 3:
How would the level of aggregate demand
be affected by a rise in the interest rate in
the Keynesian theory? Explain.

16. Question 4 :
Using IS-LM model, explain in what situation monetary
policy and fiscal policy be very effective? Explain the
relationship from the economic interpretation

17. Fiscal Policy Effectiveness and the slope of IS
Initial equilibrium at point A where
IS0=LM0.
Government Spending increase -> IS shift
to the right from IS0 to IS1 -> MS<MD ->
ES]DM(A) -> sell bond -> price of bond
decrease -> r increase
r decrease :
• i (low)  I decrease in small amount ->
Y increase in large amount from Ya to Yc
-> equilibrium point move from A to C
• i (high)  I decrease in large amount ->
Y increase in small amount from Ya to Yb
-> equilibrium point move from A to B
• i=o  I is completely interest-insensitive
Conclusion :
 Fiscal policy is more effective when IS is
steep

18. Fiscal Policy Effectiveness and the slope of LM
Initial equilibrium at point A where IS0=LM0.
Government Spending increase -> IS shift to
the right from IS0 to IS1 -> MS<MD ->
ES]DM(A) -> sell bond -> price of bond
decrease -> r increase
r increase :
• C2 (low)  I decrease in large amount -> Y
increase in small amount from Ya to Yc ->
equilibrium point move from A to C
• C2 (high)  I decrease in small amount -> Y
increase in large amount from Ya to Yb ->
equilibrium point move from A to B
• C2 =o  private I had declined by an
amount just equal to the increase in G -> Y
remain unchanged.
Conclusion :
 LM curve flat, fiscal policy is effective but
when LM curve is vertical, monetary is the
most effective.

19. Monetary Policy Effectiveness and the
slope of LM
Initial equilibrium at point A where IS0=LM0.
Money Supple increase -> LM shift to the
right from LM0 to LM1 -> MS>MD -> ESM(A)
-> buy bond -> price of bond increase -> r
drop
r decrease :
• C2 (low)  I increase in small amount -> Y
increase in small amount from Ya to Yc ->
equilibrium point move from A to C
• C2 (high)  I increase in large amount -> Y
increase in large amount from Ya to Yb ->
equilibrium point move from A to B
• C2 =o  I is completely insensitive to
changes in r -> Y remain unchanged.
Conclusion :
 LM curve steep, monetary policy is effective
but when LM curve is vertical, monetary is
the most effective.

20. Monetary Policy Effectiveness and
the slope of IS
Initial equilibrium at point A where IS0=LM0.
Money Supple increase -> LM shift to the
right from LM0 to LM1 -> MS>MD -> ESM(A)
-> buy bond -> price of bond increase -> r
drop
r decrease :
• i (low)  I increase in small amount -> Y
increase in small amount from Ya to Yc ->
equilibrium point move from A to C
• i (high)  I increase in large amount -> Y
increase in large amount from Ya to Yb ->
equilibrium point move from A to B
• i=o  I is completely insensitive to
changes in r -> Y remain unchanged.
Conclusion :
 IS curve flat, monetary policy is effective

21. MONETARY AND FISCAL POLICY EFFECTIVENESS
AND THE SLOPE OF THE IS AND LM SCHEDULES
Monetary Policy
IS Schedule LM Schedule
Steep Ineffective Effective
Flat Effective Ineffective
Fiscal Policy
IS Schedule LM Schedule
Steep Effective Ineffective
Flat Ineffective Effective