Goods and Financial Markets1: IS-LM

Goods and Financial Markets1: IS-LM

Goods and Financial Markets1: IS-LM Goal: link the goods and the financial markets into a more general model that will determine the equilibrium Y and the equilibrium i in the economy in the short run (with fixed prices) The goods market will be represented by the IS curve (standing for investment-savings) The financial markets (money market) will be represented by the LM curve (liquidity-money) 1. The Hicks-Hansen model based on Keynes General Theory BlCh5 1 The goods market - IS curve Equilibrium condition Y = Z C + I + G Investment will provide the link to the financial markets Determinants of investment: If sales increase, producers might want to increase their productive capacity Y If the rate of interest rate i increases, producers find that borrowing to add new capital becomes more expensive + -

BlCh5 I = I(Y,i) 2 Equilibrium in the goods market becomes: Y = C(Y-T)+I(Y,i) + G Basically When i When i I I and Ye and Ye The ZZ curve shifts as the interest rate changes and a multiplier effect takes place If MPI is the marginal propensity to invest out of new income, assume that MPC + MPI < 1 The slope of the ZZ curve is MPC + MPI and the interest rate is included in the intercept BlCh5

3 Construction of the IS curve Y=Z Z ZZ(i) When the interest rate increases, I (Y, i) drops ZZ(i) and the ZZ curve shifts down. The economy contracts from Ye to Ye. i Ye i i Ye E E

i BlCh5 Y IS Y e Y e E and E correspond to 2 combinations of i and Y, such that the good market is in equilibrium. Y 4 The IS curve

Y = C(Y-T)+I(Y, i) + G Definition: All the combinations of i and Y such that the goods market is in equilibrium i.e. the above equation is satisfied Shift of the IS: A change in any of the exogenous variables in the equation will cause IS to shift. Shift variables: c0 and I0 (confidence variables) T and G (policy - fiscal - variables) BlCh5 5 Expansionary fiscal policy: increase in G Y=Z Z ZZ(G+G) ZZ (G) G Ye Y

Ye i E i E IS IS BlCh5 Ye Ye Y When G increases, ZZ shifts up and IS shifts to the right. An increase in T would has the

opposite effect as it is contractionary. 6 Shifts of IS i G T c0 I0 G T c0 I0 IS Y BlCh5 7 The financial markets - LM curve Equilibrium condition1: supply of money = demand for money

Ms = PYL(i) or Ms/P = YL(i) (Ms/P is the real money supply) It is clear that both LM and IS are relations between i and Y 1. The bonds market is automatically in equilibrium when the money market is in equilibrium BlCh5 8 Construction of the LM curve Ms i i LM E i1 i0 BlCh5 Md(Y1>Y0) Md(Y0) M/P

E Y0 Y1 Y 9 The LM curve Ms = PYL(i) Definition: All the combinations of i and Y such that the financial markets (bonds and money) are in equilibrium Shift of the LM curve: a change in the money supply or a change in price or an exogenous shift in the money demand An increase in the money supply ( or a decrease in price) is expansionary A change in the velocity of money BlCh5 10 Expansionary monetary policy: an

increase in Ms Ms Ms i i LM LM A i0 i1 Md(Y0) M/P BlCh5 A Y0 Y1 Y 11

Shifts of LM i o C M P V c a r t n n o ti y r a LM Ms P

V s Ex n a p n o i s y r a Y BlCh5 12

Recently Viewed Presentations

  • Cathode Discharge Simulation

    Cathode Discharge Simulation

    Then, I made a SPICE circuit simulation of the field cage discharge to compare with my results ... SPICE. PYTHON. What's Next? Now, I'm working on using these simulations of the changing voltage in the cathode to look at what...

    [email protected] Kelli Kwiatkowski ... by Penny Choice and Dr. Sally Walker SKYWARD STUDENT INFORMATION SYSTEM SKYWARD CATEGORIES CAN BE TWEAKED SKYWARD The Gifted and Talented module seems to be there just for reporting purposes. The RtI module can be tweaked...
  • 2010 TCT Refresher - United States Coast Guard

    2010 TCT Refresher - United States Coast Guard

    Leaders do take advantage of everyone's ideas and experience and remain adaptable to new conditions and challenges. ... 3 years boating, crew trainee, third time on an Auxiliary vessel under orders, first time with this vessel and crew, and first...
  • Geen diatitel

    Geen diatitel

    Next read the quiz script - and make notes of new vocabulary. Finish off by the 'post-listening' task(s). Make prints of your answers as proof for your portfolio. You would like to get more practice with listening to American or...
  • GIT Control - Association for Computing Machinery

    GIT Control - Association for Computing Machinery

    Typical Day with Git. Really Good Day. git fetch <remote> <feature branch> Or git pull. Work on code. git status. git add <file(s) I worked on/edited> git commit -m "<message about what I fixed with maybe a tag for ticket...
  • DOTIN Earphone/Hands Free Stereo Sound Bass SMART PHONE

    DOTIN Earphone/Hands Free Stereo Sound Bass SMART PHONE

    Dotin introducing products with new innovations in High performance stereo earphones and headphones like active noise cancellation, volume control Key, In-Ear design, multi channel sound output, automatic recognition of mobile phone, etc. so you can enjoy features of your phone....
  • Title in All Caps

    Title in All Caps

    * Global Level Influenza occurs globally with an annual attack rate estimated at 5-10% in adults and 20-30% in children. Worldwide, annual epidemics result in an approximately one billion cases of influenza, about three to five million cases of severe...
  • The 2011 Poker TDA Summit June 29  30

    The 2011 Poker TDA Summit June 29 30

    Many questions have been submitted on this topic for the 2011 TDA Summit. In the interest of looking at this subject comprehensively, it is included in the Situations & Procedures Section. Review of this topic in Situations & Procedures ....