Tutorial
1. Dec 2019 Question 5
(c) Using diagrams, explain the effectiveness of monetary policy and fiscal policy in the
situation when the investment and the net export are completely insensitive towards the
changes in the interest rate. Commented [HM1]: Investment and net export do not
Monetary policy Answer: (Monetary policy) A situation that can easily influence changes interest rate
describe monetary policy’s ineffectiveness is through the
liquidity trap situation. Assume the Central Bank of the
country expands money supply equal to the horizontal
distance EH that shifts the LM1 curve to LM2. With the given
IS curve the new equilibrium is at point B. It will be seen
from the new equilibrium at point B that the slight fall of the
interest. In simpler words, real national income hardly
increases for it to provide any significant positive impact
toward the economy. This proves that monetary policy is
inefficient.
(Fiscal policy) The government increases its expenditure
or/and reduces taxes in the case of expansionary fiscal
policy, which shifts the IS curve to the right. An increase in
government spending or a decrease in taxes shifts the IS
curve upwards to IS which intersects the LM curve at E 1.
This will then raise the national income from OY to OY 1.The
rise in the national income will increase the demand for
money, given the money supply is fixed. In return, this will
raise the interest rate from OR to OR 1. The increase in the
interest rate is prone to reduce private investment
expenditure at the same time the government expenditure
is being increased.
2. June 2019 Question 5
(f) Using suitable diagrams, explain the effectiveness of employing monetary policy as
compared to fiscal policy in the situation when money demand is unaffected by the interest Commented [HM2]: Monetary>fiscal
rate. (10 marks)
Commented [HM3]: Without any relation of money
demand by interest rate.
Answer: Monetary policy is more effective in
comparison to fiscal policy because, a small
amount of inflation is healthy for a growing
economy as it encourages investment in the
future and allows workers to expect higher
wages. Inflation occurs when the general price
levels of all goods and services in an economy
increases. By raising the target interest rate,
investment becomes more expensive and works
to slow economic growth a bit. Monetary policy
is used to either stimulate an economy or to
inspect its growth. Through restricting spending
and encouraging savings, monetary policy can
act as an inflation brake.
1. Dec 2019 Question 5
(c) Using diagrams, explain the effectiveness of monetary policy and fiscal policy in the
situation when the investment and the net export are completely insensitive towards the
changes in the interest rate. Commented [HM1]: Investment and net export do not
Monetary policy Answer: (Monetary policy) A situation that can easily influence changes interest rate
describe monetary policy’s ineffectiveness is through the
liquidity trap situation. Assume the Central Bank of the
country expands money supply equal to the horizontal
distance EH that shifts the LM1 curve to LM2. With the given
IS curve the new equilibrium is at point B. It will be seen
from the new equilibrium at point B that the slight fall of the
interest. In simpler words, real national income hardly
increases for it to provide any significant positive impact
toward the economy. This proves that monetary policy is
inefficient.
(Fiscal policy) The government increases its expenditure
or/and reduces taxes in the case of expansionary fiscal
policy, which shifts the IS curve to the right. An increase in
government spending or a decrease in taxes shifts the IS
curve upwards to IS which intersects the LM curve at E 1.
This will then raise the national income from OY to OY 1.The
rise in the national income will increase the demand for
money, given the money supply is fixed. In return, this will
raise the interest rate from OR to OR 1. The increase in the
interest rate is prone to reduce private investment
expenditure at the same time the government expenditure
is being increased.
2. June 2019 Question 5
(f) Using suitable diagrams, explain the effectiveness of employing monetary policy as
compared to fiscal policy in the situation when money demand is unaffected by the interest Commented [HM2]: Monetary>fiscal
rate. (10 marks)
Commented [HM3]: Without any relation of money
demand by interest rate.
Answer: Monetary policy is more effective in
comparison to fiscal policy because, a small
amount of inflation is healthy for a growing
economy as it encourages investment in the
future and allows workers to expect higher
wages. Inflation occurs when the general price
levels of all goods and services in an economy
increases. By raising the target interest rate,
investment becomes more expensive and works
to slow economic growth a bit. Monetary policy
is used to either stimulate an economy or to
inspect its growth. Through restricting spending
and encouraging savings, monetary policy can
act as an inflation brake.
