Question

Consider the standard the IS-MP-Phillips Curve model. Explain what happens to the economy if there is a temporary negative shock to investment demand. a. Initially, suppose the central bank does not change the nominal interest rate. Explain how and why IS curve changes. What change, if any, do you expect in inflation?

Answer 1

A temporary negative shock to investment demand in the IS-MP-Phillips Curve model would lead to a decrease in output and potentially a decrease in inflation in the short run.

Step-by-step explanation:

In the IS-MP-Phillips Curve model, a temporary negative shock to investment demand would primarily impact the IS curve. The IS curve represents the relationship between interest rates and the level of output in the economy. A decrease in investment demand would lead to a decrease in output and a leftward shift of the IS curve.

This decrease in aggregate demand could lead to a decrease in inflation, or even deflation. With less investment spending, businesses may have to lower prices to stimulate demand and sell their goods or services.

Overall, a temporary negative shock to investment demand would result in a decrease in output and potentially a decrease in inflation in the short run.