*The question I’m working on and my answer are below. My question to you is; can output be restored by lowering
the interest rate causing a downward shift in the LM curve and thus increasing output?
Question: Graphically (i.e., using the IS-LM model) illustrate and explain what effect an increase in default-risk premium (x) will have on the equilibrium output. How can we restore the output to its original level following this change?
Answer: Increase in default-risk premium (x) will make investing in assets riskier causing a decrease in investment demand. The IS curve shifts to the left showing interest rate and output both decreases. Output can be restored by lowering the interest rate causing a downward shift in the LM curve and thus increasing output.
