FACULTY BUSINESS AND MANAGEMENT

BACHELOR OF BUSINESS ADMINISTRATION (HONS) 

BUSINESS ECONOMICS (BA250)

INTERMEDIATE MACROECONOMICS (ECO557)

TUTORIAL

PREPARED BY:

NAME MATRIC NUMBER

FARAH SOFIA BINTI ROSLI 2022972607

NUR AIN SOLEHAH BINTI ZAINAL 2022908331

NUR NAJEHAH BINTI KAMARUDIN 2022917647

FARAH NAJWA BINTI MOHD 2022755841

ALHUSHAIRI

CLASS:
D2BA2503C

PREPARED FOR:
MADAM SYAZWANI BINTI A. MALEK @ ABDUL MALEK

SUBMISSION DATE:
4 JANUARY 2023
 1. Bank Negara Malaysia has announced that the Government intends to adopt
expansionary fiscal policy to offset the recent drop in real output. Use an IS-LM
diagram to help explain your concerns regarding the possibility that the
suggested policy is ineffective.

Crowding-out effect originates from government deficit spending, but this excess spending
fails to raise income (GDP) as it is offset by a fall in consumption and investment which
include real output. Crowding-out occurs when the government runs a deficit budget causing
interest rates to increase and thus reduces personal consumption and private investment in
the economy. The increase in interest rate has choked-off consumption and investment and
they offset the initial increase in government spending. This arises when the government
implements an expansionary fiscal policy by planning a deficit budget. The government
makes more injections by raising its expenditure and reducing the taxes to improve
aggregate demand and will in turn raise national income. However, an increase in interest
makes investment falls and is called the crowding-out effect.

Partial crowding-out happens when the decrease in investment only offset part of the initial
increase in government spending. This happens in all typical cases where the IS curve
slopes downwards and LM curve slopes upwards. However, the degree of partial crowding-
out very much depends on the slopes of LM and/or IS curves. The graph illustrates a
condition where money demand is interest inelastic relative to investment that is interest
elastic. So, the IS curve is steep and LM is flatter. A deficit spending by the government
shifts the IS curve to the right to IS1 and with full multiplier effect and income level can
increase to Y*. However, the economy is now out of equilibrium that forces interest to rise
and the following effect is a decrease in investment. Since investment in this economy is
elastic towards interest rate, there is a large decrease in it and income falls by a rate from Y*
to Y1. Overall, the expansionary fiscal policy only makes income increase by a small rate
from Y0 to Y1. the impact of crowding-out effect is large which is Y*Y1.

2. With the help of diagrams of money market, IS-LM and AS-AD, demonstrate
and explain the effects of decrease in demand for money as a result of greater
use of payment technologies in promoting economic growth.

The money demand curve shows the inverse relationship between interest rate and the
quantity of money demanded. The money demand curve is downward sloping, and it has a
negative slope. The money supply curve shows no relationship between interest rate and
quantity of money. The rise in the interest rate or fall in interest rate results from no change
in output. The money supply curve is vertical.
The money market diagram shows that the money demand curve decreases with the same
money supply curve such that the rate of interest falls and the output remains the same. It
means the equilibrium rate of interest falls and equilibrium output remains the same into an
economy. The IS and LM curve remains the same with the change in the money demand
curve. The aggregate demand curve remains the same over a period of time.

The above diagram shows that the money demand curve reduces from MD to MD' then the
interest rate falls from i to i' and output remains the same.

3. Using the IS-LM model, explain and show graphically the effect of a fiscal
expansion when the demand for money is completely insensitive to changes in
the interest rate.
Name this effect and explain what it is.

Crowding-out effect originates from government deficit spending, but this excess
spending fails to raise income (GDP) as it is offset by a fall in consumption and
investment. Crowding-out occurs when the government runs a deficit budget causes
interest rate to increase. The increase in interest rate has choked-off consumption
and investment, and they offset the initial increase in government spending. This
arises when the government implement an expansionary fiscal policy by planning a
deficit budget. Under such condition, LM curve will be vertical. The vertical LM curve
implies that fiscal policy will be quite ineffective in dealing with recession or it cannot
raise the level of output.

11 Following is the diagram:

In an IS-LM model, if we assume that money demand is completely insensitive to

changes in the interest rate because interest rates cannot be lowered by fiscal policy.
This is the case when LM is perfectly inelastic and thus national income does not
change at all.