What happens to the IS and LM curves in the short-run when the government increases taxes?
LM curve: Nothing happens to the LM curve, because the LM curve deals with the financial market. The LM relation is M/P = YL(i). As you can see, taxes is not included in the LM relation. IS curve: The IS curve shifts. The IS relation is Y = C + I + G = C(Y-T) + I(Y,i) + G. If taxes increase, output minus taxes decreases (Y-T), which decreases consumption and therefore output. Thus, an increase in taxes decreases output. Output is on the x-axis of the IS/LM model. Since the Is-curve is downward sloping, IS shifts to the left.The new equilibrium between the goods and the financial markets results in lower output and lower interest rate.
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