Macro 4
LM - IS model
LM - IS model
IS relation
Y must be equal to Z
production is equal to demand
2 characteristics of ZZ curve
- We have assumed that consumption and investment relations are not linear
- 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.
IS curve
- 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.
- 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.
IS curve - ZZ relation
shift of ZZ curve ⇒ movement on IS-curve
movement on ZZ curve ⇒ shift of IS-curve
LM curve
- 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.
- 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.
LM-relation
real money supply = real money demand (YL(i))
shifts in LM-curve
Increase in money supply ⇒ decrease i-rate ⇒ shift down
Decrease money supply ⇒ increase i-rate ⇒ shift up
(at a given Y (income) level)
effect of increase in taxes (fiscal policy)
- 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
effects of monetary expansion (monetary policy)
- affects the LM-curve
- with given level of income, increase in money leads to a decrease in the interest rate
- increase in money ⇒ lower interest rate ⇒increase in investment ⇒ increase in demand and output
fiscal contraction
Increasing taxes while keeping government spending unchanged
Dynamics of consumers and firms (4)
• Consumers are likely to take some time to adjust their consumption following a change in disposable income. • Firms are likely to take some time to adjust investment spending following a change in their sales. • Firms are likely to take some time to adjust investment spending following a change in the interest rate. • Firms are likely to take some time to adjust production following a change in their sales.
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Flashcards
IS relation
Y must be equal to Z
production is equal to demand
2 characteristics of ZZ curve
- We have assumed that consumption and investment relations are not linear
- 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.
IS curve
- 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.
- 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.
IS curve - ZZ relation
shift of ZZ curve ⇒ movement on IS-curve
movement on ZZ curve ⇒ shift of IS-curve
LM curve
- 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.
- 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.
LM-relation
real money supply = real money demand (YL(i))
shifts in LM-curve
Increase in money supply ⇒ decrease i-rate ⇒ shift down
Decrease money supply ⇒ increase i-rate ⇒ shift up
(at a given Y (income) level)
effect of increase in taxes (fiscal policy)
- 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
effects of monetary expansion (monetary policy)
- affects the LM-curve
- with given level of income, increase in money leads to a decrease in the interest rate
- increase in money ⇒ lower interest rate ⇒increase in investment ⇒ increase in demand and output
fiscal contraction
Increasing taxes while keeping government spending unchanged
Dynamics of consumers and firms (4)
• Consumers are likely to take some time to adjust their consumption following a change in disposable income. • Firms are likely to take some time to adjust investment spending following a change in their sales. • Firms are likely to take some time to adjust investment spending following a change in the interest rate. • Firms are likely to take some time to adjust production following a change in their sales.
