Macro 4

Y must be equal to Z

production is equal to demand

1. We have assumed that consumption and investment relations are not linear
2. ZZ is flatter than 45-degree line because we assume that an increase in output leads to a less than one-for-one increase in demand.

1. An increase in the interest rate decreases the demand for goods at any level of output, leading to a decrease in the equilibrium level of output.
2. Equilibrium in the goods market implies that an increase in the interest rate leads to a decrease in output. The IS curve is therefore downward sloping.

shift of ZZ curve ⇒ movement on IS-curve

movement on ZZ curve ⇒ shift of IS-curve

1. An increase in income leads, at a given interest rate, to an increase in the demand for money. Given the money supply, this increase in the demand for money leads to an increase in the equilibrium interest rate.
2. Equilibrium in the financial markets implies that an increase in income leads to an  increase in the interest rate. The LM curve is therefore upward sloping.

real money supply = real money demand (YL(i))

Increase in money supply ⇒ decrease i-rate ⇒ shift down

Decrease money supply ⇒ increase i-rate ⇒ shift up

(at a given Y (income) level)

• Affects only IS-curve
• lower disposable income ⇒ decrease consumption (demand) ⇒ decrease in income & output ⇒ reducing the demand for money ⇒ decrease in interest rate
• the decline in interest rate reduces but not completely offset the effect of higher taxes on the demand of goods