This document summarizes key concepts from an intermediate macroeconomics textbook chapter on the Neoclassical IS-LM model. It introduces the IS-LM model and its components - the IS curve representing goods market equilibrium and the LM curve representing money market equilibrium. It derives the equations for the IS and LM curves and shows how their intersection determines equilibrium income and interest rates. It discusses how fiscal and monetary policy can shift the IS and LM curves and their effectiveness depending on the curves' slopes and shifts.
The document discusses using the IS-LM model to analyze the effects of monetary and fiscal policy. It provides diagrams demonstrating how:
1) Expansionary fiscal policy shifts the IS curve to the right, increasing output, while contractionary fiscal policy shifts it left, decreasing output.
2) Expansionary monetary policy shifts the LM curve to the right, lowering interest rates and increasing output, while contractionary monetary policy shifts LM left, raising rates and reducing output.
3) Fiscal policy can be partially or completely crowded out by higher interest rates, reducing its effectiveness in boosting output. The degree of crowding out depends on how sensitive investment and money demand are to interest rate changes.
Fiscal policy uses government spending, taxes, and borrowing to influence macroeconomic variables. Expansionary fiscal policy, such as tax cuts or increased spending, increases aggregate demand to boost a recession-plagued economy. Contractionary fiscal policy, like tax increases or spending cuts, decreases aggregate demand to curb inflation. Automatic stabilizers like unemployment insurance and the progressive tax system counter cyclical changes automatically. Discretionary policy actively manipulates fiscal tools but faces time lags and crowding out effects.
This document discusses the IS-LM model of macroeconomic equilibrium. It provides the following key points:
1. The IS curve and LM curve represent equilibrium in the goods/commodity market and money market respectively, with their intersection representing overall macroeconomic equilibrium.
2. At the equilibrium point, aggregate demand equals aggregate supply in the goods market, and money demand equals money supply.
3. The IS-LM model integrates monetary and fiscal policy and is based on factors like investment demand, consumption, and money demand/supply. Changes to these factors shift the curves and alter the equilibrium level of income.
4. The model is criticized for assuming interest rates are flexible and markets are independent,
This document provides an overview of the Keynesian model of aggregate demand. It explains that aggregate demand is the total demand for final goods and services in an economy at a given price level. The AD curve is derived from the intersection of the IS curve, which shows combinations of output and interest rates that equal planned and actual expenditures, and the LM curve, which shows combinations that clear the money market. An increase in government purchases shifts the AD curve to the right, increasing both output and the price level if the aggregate supply curve is upward sloping.
Macroeconomic policies can influence economic activity through monetary policy and fiscal policy. Monetary policy uses interest rates and the money supply to impact aggregate demand, while fiscal policy uses government spending and taxation. Both aim to achieve objectives like economic growth and low unemployment, while maintaining price stability. Supply-side policies also aim to boost potential output through measures like tax reform, education and training programs.
John Maynard Keynes was an English economist born in 1883 who developed theories advocating for government intervention in the economy. He believed governments should increase spending and cut taxes during recessions to stimulate demand and employment. This "multiplier effect" would lead to increased manufacturing output and incomes in a self-sustaining cycle. Keynes' theories were influential during the Great Depression and World War II, when deficit spending helped countries recover. While his ideas do not dominate modern economics, aspects of his approach influenced recent economic stimulus packages.
The document discusses fiscal policy, which are changes in government spending and taxes that influence macroeconomic goals. It defines expansionary and contractionary fiscal policy and discusses discretionary versus automatic fiscal policy. It also examines the effects of fiscal policy using the Keynesian model and explores factors that could limit the effectiveness of fiscal policy like lags, crowding out, and supply-side considerations.
Keynes proposed that as income increases, consumption increases but not as much as the rise in income, meaning the marginal propensity to consume is less than one. The relationship between consumption and income can be expressed as C=A+BY, where C is consumption, A is autonomous consumption, B is the marginal propensity to consume, and Y is real disposable income. When total income in a community increases, consumption spending also increases but to a lesser degree, so increased income is split between consumption and savings.
The document discusses using the IS-LM model to analyze the effects of monetary and fiscal policy. It provides diagrams demonstrating how:
1) Expansionary fiscal policy shifts the IS curve to the right, increasing output, while contractionary fiscal policy shifts it left, decreasing output.
2) Expansionary monetary policy shifts the LM curve to the right, lowering interest rates and increasing output, while contractionary monetary policy shifts LM left, raising rates and reducing output.
3) Fiscal policy can be partially or completely crowded out by higher interest rates, reducing its effectiveness in boosting output. The degree of crowding out depends on how sensitive investment and money demand are to interest rate changes.
Fiscal policy uses government spending, taxes, and borrowing to influence macroeconomic variables. Expansionary fiscal policy, such as tax cuts or increased spending, increases aggregate demand to boost a recession-plagued economy. Contractionary fiscal policy, like tax increases or spending cuts, decreases aggregate demand to curb inflation. Automatic stabilizers like unemployment insurance and the progressive tax system counter cyclical changes automatically. Discretionary policy actively manipulates fiscal tools but faces time lags and crowding out effects.
This document discusses the IS-LM model of macroeconomic equilibrium. It provides the following key points:
1. The IS curve and LM curve represent equilibrium in the goods/commodity market and money market respectively, with their intersection representing overall macroeconomic equilibrium.
2. At the equilibrium point, aggregate demand equals aggregate supply in the goods market, and money demand equals money supply.
3. The IS-LM model integrates monetary and fiscal policy and is based on factors like investment demand, consumption, and money demand/supply. Changes to these factors shift the curves and alter the equilibrium level of income.
4. The model is criticized for assuming interest rates are flexible and markets are independent,
This document provides an overview of the Keynesian model of aggregate demand. It explains that aggregate demand is the total demand for final goods and services in an economy at a given price level. The AD curve is derived from the intersection of the IS curve, which shows combinations of output and interest rates that equal planned and actual expenditures, and the LM curve, which shows combinations that clear the money market. An increase in government purchases shifts the AD curve to the right, increasing both output and the price level if the aggregate supply curve is upward sloping.
Macroeconomic policies can influence economic activity through monetary policy and fiscal policy. Monetary policy uses interest rates and the money supply to impact aggregate demand, while fiscal policy uses government spending and taxation. Both aim to achieve objectives like economic growth and low unemployment, while maintaining price stability. Supply-side policies also aim to boost potential output through measures like tax reform, education and training programs.
John Maynard Keynes was an English economist born in 1883 who developed theories advocating for government intervention in the economy. He believed governments should increase spending and cut taxes during recessions to stimulate demand and employment. This "multiplier effect" would lead to increased manufacturing output and incomes in a self-sustaining cycle. Keynes' theories were influential during the Great Depression and World War II, when deficit spending helped countries recover. While his ideas do not dominate modern economics, aspects of his approach influenced recent economic stimulus packages.
The document discusses fiscal policy, which are changes in government spending and taxes that influence macroeconomic goals. It defines expansionary and contractionary fiscal policy and discusses discretionary versus automatic fiscal policy. It also examines the effects of fiscal policy using the Keynesian model and explores factors that could limit the effectiveness of fiscal policy like lags, crowding out, and supply-side considerations.
Keynes proposed that as income increases, consumption increases but not as much as the rise in income, meaning the marginal propensity to consume is less than one. The relationship between consumption and income can be expressed as C=A+BY, where C is consumption, A is autonomous consumption, B is the marginal propensity to consume, and Y is real disposable income. When total income in a community increases, consumption spending also increases but to a lesser degree, so increased income is split between consumption and savings.
The document discusses the transmission mechanism of monetary policy through four key points:
1. It introduces the transmission mechanism and defines it as the series of links between monetary policy changes and their impacts on output, employment, and inflation.
2. It outlines the session, which will cover the impact of interest rate changes on other interest rates, consumption, and investment.
3. It provides brief definitions and discussions of consumption and investment, and how monetary policy influences them through several channels like interest rates, asset prices, and exchange rates.
4. It notes that monetary policy is likely to influence aggregate demand in various ways and that the relationship between interest rates and aggregate demand is complex, being influenced by expectations and time
The document summarizes key aspects of the Keynesian economic model, including:
1) The multiplier effect, where any change in aggregate demand is amplified through subsequent rounds of spending.
2) How the model shows equilibrium output (Y) is determined by the multiplier and total injections (autonomous consumption and investment).
3) The paradox of thrift, where if the whole economy tries to increase savings simultaneously, it can reduce aggregate demand and output.
4) Keynes' critique of the neoclassical theory of savings and investment, disagreeing that savings is a function of interest rates or that investment can be analyzed while holding expectations constant.
This document discusses the three motives that drive individuals' demand for money: transactionary, precautionary, and speculative. Transactionary demand refers to money held for regular purchases and bills that are paid periodically but not simultaneously to when individuals are paid. Precautionary demand is money held for unforeseen life events. Speculative demand arises from hoping to profit from changes in bond prices, with higher interest rates reducing speculative money holding as bonds become more attractive. Overall, demand for money results from the combination of needs for transactions, precautions, and speculation.
1. The document discusses the construction of the aggregate demand (AD) and aggregate supply (AS) curves from the IS-LM model.
2. It explains how the AD curve can be derived by observing how changes in the price level affect output and interest rates in the IS-LM model.
3. It then discusses sources of wage rigidity, including institutional factors like employment contracts, which allow the construction of the AS curve based on a fixed nominal wage level.
This document provides an overview of macroeconomics topics that will be covered in the Macroeconomics 2 course, including integrating classical and Keynesian schools of thought, the development of the New Neoclassical Synthesis, short and long run issues, and applications of macroeconomic models. It also summarizes the key differences between classical and Keynesian economics, including their views on unemployment, flexibility of wages and prices, and the appropriate role of government intervention in the economy.
The document discusses the effectiveness of fiscal and monetary policies using the IS-LM model. It explains that the effectiveness of these policies depends on the slopes of the IS and LM curves. Steeper IS and flatter LM curves make fiscal policy more effective, while flatter IS and steeper LM curves make monetary policy more effective. The document analyzes different scenarios regarding the slopes of the curves and their implications for crowding out and crowding in. It also discusses using a policy mix of expansionary monetary policy and relatively tight fiscal policy.
The neoclassical theory of interest, or loanable funds theory, holds that the interest rate is determined by the supply and demand for loanable funds. The demand for loanable funds comes from investment, consumption/dissaving, and hoarding. The supply comes from savings, bank credit, dishoarding, and disinvestment. The interest rate reaches equilibrium when the total demand for loanable funds equals the total supply. Critics argue the theory assumes full employment, does not precisely determine the interest rate, and is impractical.
This chapter discusses debates around stabilization policy. It considers whether policy should be active or passive in response to economic fluctuations, and whether policy should be set by rule or allow discretion. Arguments for active policy include reducing economic hardship, while arguments for passive policy cite lags in policy effects. Rules are argued to increase credibility and avoid time inconsistency, while discretion allows flexibility. Overall there is no clear consensus from history on the best approach.
Theories of income output and employmentakanksha91
This document presents theories of income, output, and employment from a Keynesian perspective. It introduces John Maynard Keynes and his work, including his general theory. It discusses Keynesian beliefs that markets will not automatically lead to full employment and that the level of output and national income can adjust. The main Keynesian theories are outlined, including the labor market, money market, multiplier effect, and inflation theory. The document then explains Keynes' theory of income, output, and employment determination through the intersection of aggregate demand and supply curves. It concludes that in the short run, aggregate demand determines employment, output, and income levels according to Keynes.
KEY TAKE AWAY:
What is Monetary policy?
Objectives of Monetary policy?
Types of Monetary policy?
Tools of Monetary policy?
Significance of Monetary policy?
The Harrod-Domar model theorizes that a country's economic growth rate is defined by its savings level and capital output ratio. It was developed in the 1930s-40s by British economist Roy Harrod and Russian economist Evsey Domar. The model shows that increased savings leads to increased investment, production, and capital, fueling economic growth. However, it makes unrealistic assumptions and does not account for factors like development versus just growth. The Solow-Swan model later improved on it by including capital intensity variations.
The document summarizes key concepts from chapter twelve of Mankiw's macroeconomics textbook on aggregate demand in an open economy. It introduces the Mundell-Fleming model and its assumptions. It shows how fiscal and monetary policy impact the economy differently under floating versus fixed exchange rates. Specifically, fiscal policy is powerful under fixed rates but monetary policy is powerful under floating rates. It also examines the effects of changes in the exchange rate, interest rates, money supply, and price levels in the Mundell-Fleming model framework.
The document discusses deadweight loss that occurs due to taxes and monopolies. It provides the following key points:
- A tax creates a wedge between the price paid by buyers and received by sellers, resulting in a reduction in quantity traded and deadweight loss for society. The size of the deadweight loss depends on the price elasticities of supply and demand.
- Monopolies also create deadweight loss by setting price above marginal cost. Price discrimination allows monopolies to reduce deadweight loss by charging different prices to different customers.
- Estimating deadweight loss is difficult but important for evaluating market efficiency. Two approaches discussed are Harburger's method using industry profit margins and Cowling and Mueller's method
Relative effectiveness of Monetary and Fiscal Policy in IS-LM FrameworkAamin22
This document summarizes the relative effectiveness of monetary and fiscal policy using an IS-LM framework. It discusses that monetary policy is more effective when the LM curve is steeper, meaning demand for money is less interest elastic. Fiscal policy is more effective when the LM curve is flatter and the IS curve is steeper. The effectiveness of both policies depends on the slope of the IS and LM curves. Monetary policy is completely ineffective if the LM curve is horizontal, while fiscal policy is completely ineffective if the IS curve is horizontal or the LM curve is vertical.
environment eco-1 Coase theorem and Hedonic p.pdfJanmejayaAcharya
The document discusses the Coase Theorem and hedonic pricing. The Coase Theorem states that when property rights are well-defined and transaction costs are low, private negotiations can lead to an efficient outcome regardless of the initial allocation of property rights. It is based on assumptions of few parties, low negotiation costs, no transaction costs or wealth/income effects, and no government interference. Hedonic pricing uses surrogate goods like housing prices to value environmental attributes by analyzing how characteristics like proximity to parks or mines affect prices. Regression analysis estimates how asset prices vary with characteristics to derive implicit prices for non-market goods.
Fiscal policy involves government spending, taxation, and borrowing to influence economic activity. There are three main views on fiscal policy: Keynesian, New Classical, and Supply-Side. Keynesians support using deficits during recessions and surpluses during booms. New Classical economists argue deficits only affect tax timing. Supply-Siders emphasize reducing marginal tax rates to boost labor and investment. Automatic stabilizers and difficulties with proper timing make discretionary policy challenging with both benefits and risks.
1) The chapter uses the IS-LM model to analyze the effects of fiscal and monetary policy shocks on aggregate output and the interest rate in the short run.
2) Fiscal policy like increases in government spending or tax cuts shift the IS curve right, raising output. Monetary policy like increases in the money supply shift the LM curve down, lowering interest rates and raising output.
3) Shocks like increases in wealth from a stock market boom shift the IS curve right, raising output, while shocks that increase money demand like credit card fraud shift the LM curve left, lowering output.
4) In the long run, price adjustments return output to potential as the price level falls to accommodate any short
This document discusses the IS curve, which shows the relationship between interest rates and national income in Keynesian economics. It explains that the IS curve slopes downward, as lower interest rates lead to higher investment and thus higher national income. The document outlines how Keynes, Hicks, Hansen, Lerner and Johnson developed the idea of the IS curve to show the interaction between the real economy and money markets. It also discusses factors that determine the position and slope of the IS curve, such as autonomous spending, interest rate elasticity of investment, and the multiplier.
1. The document discusses five potential problems with the effectiveness of fiscal policy: crowding out, time lags, politicians' expansionary bias, the legacy of debt, and not allowing the economy to self-adjust.
2. It specifically examines crowding out in more detail, outlining the three types of crowding out - resource, financial, and exchange rate crowding out - and provides diagrams to illustrate financial crowding out.
3. It also notes some evaluations of crowding out and the possibility of crowding-in through tight fiscal policy.
The document discusses Richard Stone's linear expenditure system model for analyzing consumer behavior. Some key points:
- Consumer income is split into subsistence income for minimum commodity quantities and supernumerary income for additional purchases.
- Commodities are grouped into broad categories where substitution is possible within groups but not between groups. Each group must contain substitutes and complements.
- The utility function is additive, meaning utility is independent across commodity groups. Total utility is the sum of utilities from each group.
- The linear expenditure system allows for desirable disaggregation of consumption patterns while maintaining the utility maximization framework of traditional models. It models substitution at the group level rather than for individual goods.
1. The document compares the assumptions and equilibrium income determination of the simple Keynesian model and modern Keynesian model.
2. It then analyzes how fiscal policy actions like changes in government spending and taxes would impact equilibrium income using the Keynesian model.
3. The effectiveness of monetary and fiscal policy using the IS-LM model is discussed, noting that monetary policy is most effective when the LM curve is vertical and fiscal policy is most effective when the IS curve is steep. The relationship between the slopes of the IS and LM curves and policy effectiveness is summarized in a table.
This document provides an overview of economic policy under fixed exchange rates. It discusses Robert Mundell's influential Mundell-Fleming model, which shows how monetary and fiscal policy can be used to achieve internal and external balance. The model is presented graphically using IS, LM, and BP curves. An increase in government spending is used as an example of how these curves shift in response to fiscal policy under fixed exchange rates.
The document discusses the transmission mechanism of monetary policy through four key points:
1. It introduces the transmission mechanism and defines it as the series of links between monetary policy changes and their impacts on output, employment, and inflation.
2. It outlines the session, which will cover the impact of interest rate changes on other interest rates, consumption, and investment.
3. It provides brief definitions and discussions of consumption and investment, and how monetary policy influences them through several channels like interest rates, asset prices, and exchange rates.
4. It notes that monetary policy is likely to influence aggregate demand in various ways and that the relationship between interest rates and aggregate demand is complex, being influenced by expectations and time
The document summarizes key aspects of the Keynesian economic model, including:
1) The multiplier effect, where any change in aggregate demand is amplified through subsequent rounds of spending.
2) How the model shows equilibrium output (Y) is determined by the multiplier and total injections (autonomous consumption and investment).
3) The paradox of thrift, where if the whole economy tries to increase savings simultaneously, it can reduce aggregate demand and output.
4) Keynes' critique of the neoclassical theory of savings and investment, disagreeing that savings is a function of interest rates or that investment can be analyzed while holding expectations constant.
This document discusses the three motives that drive individuals' demand for money: transactionary, precautionary, and speculative. Transactionary demand refers to money held for regular purchases and bills that are paid periodically but not simultaneously to when individuals are paid. Precautionary demand is money held for unforeseen life events. Speculative demand arises from hoping to profit from changes in bond prices, with higher interest rates reducing speculative money holding as bonds become more attractive. Overall, demand for money results from the combination of needs for transactions, precautions, and speculation.
1. The document discusses the construction of the aggregate demand (AD) and aggregate supply (AS) curves from the IS-LM model.
2. It explains how the AD curve can be derived by observing how changes in the price level affect output and interest rates in the IS-LM model.
3. It then discusses sources of wage rigidity, including institutional factors like employment contracts, which allow the construction of the AS curve based on a fixed nominal wage level.
This document provides an overview of macroeconomics topics that will be covered in the Macroeconomics 2 course, including integrating classical and Keynesian schools of thought, the development of the New Neoclassical Synthesis, short and long run issues, and applications of macroeconomic models. It also summarizes the key differences between classical and Keynesian economics, including their views on unemployment, flexibility of wages and prices, and the appropriate role of government intervention in the economy.
The document discusses the effectiveness of fiscal and monetary policies using the IS-LM model. It explains that the effectiveness of these policies depends on the slopes of the IS and LM curves. Steeper IS and flatter LM curves make fiscal policy more effective, while flatter IS and steeper LM curves make monetary policy more effective. The document analyzes different scenarios regarding the slopes of the curves and their implications for crowding out and crowding in. It also discusses using a policy mix of expansionary monetary policy and relatively tight fiscal policy.
The neoclassical theory of interest, or loanable funds theory, holds that the interest rate is determined by the supply and demand for loanable funds. The demand for loanable funds comes from investment, consumption/dissaving, and hoarding. The supply comes from savings, bank credit, dishoarding, and disinvestment. The interest rate reaches equilibrium when the total demand for loanable funds equals the total supply. Critics argue the theory assumes full employment, does not precisely determine the interest rate, and is impractical.
This chapter discusses debates around stabilization policy. It considers whether policy should be active or passive in response to economic fluctuations, and whether policy should be set by rule or allow discretion. Arguments for active policy include reducing economic hardship, while arguments for passive policy cite lags in policy effects. Rules are argued to increase credibility and avoid time inconsistency, while discretion allows flexibility. Overall there is no clear consensus from history on the best approach.
Theories of income output and employmentakanksha91
This document presents theories of income, output, and employment from a Keynesian perspective. It introduces John Maynard Keynes and his work, including his general theory. It discusses Keynesian beliefs that markets will not automatically lead to full employment and that the level of output and national income can adjust. The main Keynesian theories are outlined, including the labor market, money market, multiplier effect, and inflation theory. The document then explains Keynes' theory of income, output, and employment determination through the intersection of aggregate demand and supply curves. It concludes that in the short run, aggregate demand determines employment, output, and income levels according to Keynes.
KEY TAKE AWAY:
What is Monetary policy?
Objectives of Monetary policy?
Types of Monetary policy?
Tools of Monetary policy?
Significance of Monetary policy?
The Harrod-Domar model theorizes that a country's economic growth rate is defined by its savings level and capital output ratio. It was developed in the 1930s-40s by British economist Roy Harrod and Russian economist Evsey Domar. The model shows that increased savings leads to increased investment, production, and capital, fueling economic growth. However, it makes unrealistic assumptions and does not account for factors like development versus just growth. The Solow-Swan model later improved on it by including capital intensity variations.
The document summarizes key concepts from chapter twelve of Mankiw's macroeconomics textbook on aggregate demand in an open economy. It introduces the Mundell-Fleming model and its assumptions. It shows how fiscal and monetary policy impact the economy differently under floating versus fixed exchange rates. Specifically, fiscal policy is powerful under fixed rates but monetary policy is powerful under floating rates. It also examines the effects of changes in the exchange rate, interest rates, money supply, and price levels in the Mundell-Fleming model framework.
The document discusses deadweight loss that occurs due to taxes and monopolies. It provides the following key points:
- A tax creates a wedge between the price paid by buyers and received by sellers, resulting in a reduction in quantity traded and deadweight loss for society. The size of the deadweight loss depends on the price elasticities of supply and demand.
- Monopolies also create deadweight loss by setting price above marginal cost. Price discrimination allows monopolies to reduce deadweight loss by charging different prices to different customers.
- Estimating deadweight loss is difficult but important for evaluating market efficiency. Two approaches discussed are Harburger's method using industry profit margins and Cowling and Mueller's method
Relative effectiveness of Monetary and Fiscal Policy in IS-LM FrameworkAamin22
This document summarizes the relative effectiveness of monetary and fiscal policy using an IS-LM framework. It discusses that monetary policy is more effective when the LM curve is steeper, meaning demand for money is less interest elastic. Fiscal policy is more effective when the LM curve is flatter and the IS curve is steeper. The effectiveness of both policies depends on the slope of the IS and LM curves. Monetary policy is completely ineffective if the LM curve is horizontal, while fiscal policy is completely ineffective if the IS curve is horizontal or the LM curve is vertical.
environment eco-1 Coase theorem and Hedonic p.pdfJanmejayaAcharya
The document discusses the Coase Theorem and hedonic pricing. The Coase Theorem states that when property rights are well-defined and transaction costs are low, private negotiations can lead to an efficient outcome regardless of the initial allocation of property rights. It is based on assumptions of few parties, low negotiation costs, no transaction costs or wealth/income effects, and no government interference. Hedonic pricing uses surrogate goods like housing prices to value environmental attributes by analyzing how characteristics like proximity to parks or mines affect prices. Regression analysis estimates how asset prices vary with characteristics to derive implicit prices for non-market goods.
Fiscal policy involves government spending, taxation, and borrowing to influence economic activity. There are three main views on fiscal policy: Keynesian, New Classical, and Supply-Side. Keynesians support using deficits during recessions and surpluses during booms. New Classical economists argue deficits only affect tax timing. Supply-Siders emphasize reducing marginal tax rates to boost labor and investment. Automatic stabilizers and difficulties with proper timing make discretionary policy challenging with both benefits and risks.
1) The chapter uses the IS-LM model to analyze the effects of fiscal and monetary policy shocks on aggregate output and the interest rate in the short run.
2) Fiscal policy like increases in government spending or tax cuts shift the IS curve right, raising output. Monetary policy like increases in the money supply shift the LM curve down, lowering interest rates and raising output.
3) Shocks like increases in wealth from a stock market boom shift the IS curve right, raising output, while shocks that increase money demand like credit card fraud shift the LM curve left, lowering output.
4) In the long run, price adjustments return output to potential as the price level falls to accommodate any short
This document discusses the IS curve, which shows the relationship between interest rates and national income in Keynesian economics. It explains that the IS curve slopes downward, as lower interest rates lead to higher investment and thus higher national income. The document outlines how Keynes, Hicks, Hansen, Lerner and Johnson developed the idea of the IS curve to show the interaction between the real economy and money markets. It also discusses factors that determine the position and slope of the IS curve, such as autonomous spending, interest rate elasticity of investment, and the multiplier.
1. The document discusses five potential problems with the effectiveness of fiscal policy: crowding out, time lags, politicians' expansionary bias, the legacy of debt, and not allowing the economy to self-adjust.
2. It specifically examines crowding out in more detail, outlining the three types of crowding out - resource, financial, and exchange rate crowding out - and provides diagrams to illustrate financial crowding out.
3. It also notes some evaluations of crowding out and the possibility of crowding-in through tight fiscal policy.
The document discusses Richard Stone's linear expenditure system model for analyzing consumer behavior. Some key points:
- Consumer income is split into subsistence income for minimum commodity quantities and supernumerary income for additional purchases.
- Commodities are grouped into broad categories where substitution is possible within groups but not between groups. Each group must contain substitutes and complements.
- The utility function is additive, meaning utility is independent across commodity groups. Total utility is the sum of utilities from each group.
- The linear expenditure system allows for desirable disaggregation of consumption patterns while maintaining the utility maximization framework of traditional models. It models substitution at the group level rather than for individual goods.
1. The document compares the assumptions and equilibrium income determination of the simple Keynesian model and modern Keynesian model.
2. It then analyzes how fiscal policy actions like changes in government spending and taxes would impact equilibrium income using the Keynesian model.
3. The effectiveness of monetary and fiscal policy using the IS-LM model is discussed, noting that monetary policy is most effective when the LM curve is vertical and fiscal policy is most effective when the IS curve is steep. The relationship between the slopes of the IS and LM curves and policy effectiveness is summarized in a table.
This document provides an overview of economic policy under fixed exchange rates. It discusses Robert Mundell's influential Mundell-Fleming model, which shows how monetary and fiscal policy can be used to achieve internal and external balance. The model is presented graphically using IS, LM, and BP curves. An increase in government spending is used as an example of how these curves shift in response to fiscal policy under fixed exchange rates.
The Mundell-Fleming model is an extension of the IS-LM model to an open economy framework. It analyzes the impact of fiscal and monetary policy under different exchange rate regimes, namely fixed and flexible exchange rates.
The key equations are the IS curve (relating output and interest rate), LM curve, and the balance of payments (BP) curve. The intersection of the three curves determines macroeconomic equilibrium. The effectiveness of fiscal and monetary policy depends on the exchange rate regime and degree of capital mobility. Under flexible exchange rates and perfect capital mobility, only monetary policy is effective.
1. The document discusses the IS-LM model and how it can be used to analyze the effects of fiscal and monetary policy. It presents the IS and LM curves and how they represent equilibrium in the goods and money markets.
2. Fiscal policy like increases in government spending can shift the IS curve right, raising output and interest rates. Monetary policy like increases in the money supply can shift the LM curve down, lowering interest rates and raising output.
3. Shocks to aggregate demand are analyzed using the IS-LM model, and the model can also show the transition from short-run to long-run equilibrium when prices adjust over time.
This document summarizes the Mundell-Fleming model, which analyzes how fiscal, monetary, and trade policies affect aggregate demand in a small open economy. The model shows that under floating exchange rates, fiscal policy has no effect on output, while monetary policy shifts demand between domestic and foreign goods. Under fixed exchange rates, fiscal policy impacts output while monetary policy does not. Trade restrictions can boost domestic output under fixed but not floating rates. The document also discusses interest rate differentials and currency crises using Mexico's 1994 peso crisis as a case study.
This chapter introduces the IS-LM model, which combines the Keynesian Cross model and the liquidity preference theory to determine equilibrium income and interest rates in the short run when prices are fixed. The IS curve shows all combinations of income and interest rates that result in goods market equilibrium based on the Keynesian Cross. The LM curve shows combinations that result in money market equilibrium based on liquidity preference theory. Where the IS and LM curves intersect indicates the short-run equilibrium levels of income and interest rates. Fiscal and monetary policies can shift the IS and LM curves to influence equilibrium.
This document provides an overview of modern macroeconomic practices, including key theories such as the IS-LM model, Phillips Curve, and monetary and fiscal policy frameworks. It discusses concepts like the IS curve, monetary policy reaction functions, inflation targeting, fiscal rules, and transmission mechanisms. It also analyzes recent economic performance and developments in different countries/regions, monetary policies, debt levels, inflationary pressures, and global imbalances. Looking ahead, it notes risks from global imbalances but broad growth if issues are addressed, and need for reforms in China to balance risks of sudden adjustment.
Chapter 5 Macroeconomy Policy Practice sSabrina377028
This document provides an overview of modern macroeconomic practices, including key theories such as the IS-LM model, Phillips Curve, and monetary and fiscal policy frameworks. It discusses concepts like aggregate demand, inflation expectations, monetary policy reaction functions, and fiscal rules. Models presented include the IS-MR-PC framework and how shocks to the economy can be analyzed using the IS and Phillips curves. It also examines transmission mechanisms of monetary policy and challenges like data revisions and limits to policy effectiveness.
1. The IS-LM model shows macroeconomic equilibrium through the intersection of the investment-savings (IS) curve and the liquidity-money (LM) curve.
2. Fiscal and monetary policy can shift the IS and LM curves, impacting equilibrium income and interest rates. Expansionary fiscal policy shifts IS right, while contractionary shifts it left. Expansionary monetary policy shifts LM right, while contractionary shifts it left.
3. The effectiveness of fiscal and monetary policy can be undermined by crowding out or a liquidity trap. When money demand is very sensitive to interest rates, fiscal policy expansion may be offset by rising rates. Monetary policy is ineffective in a liquidity trap
CHAPTER 6 PART 2 BEEB2023 MACRO A221.pptxRahimahEmma
1) The document discusses how the slope of the IS and LM curves affects the effectiveness of monetary and fiscal policy in the IS-LM model.
2) Monetary policy is more effective when the IS curve is flat and the LM curve is steep. Fiscal policy is more effective when the IS curve is steep and the LM curve is flat.
3) When either the IS or LM curve is vertical, monetary policy is completely ineffective while fiscal policy is most effective, as the income effect is equal to the full policy shift.
CH 3.2 Macro8_Aggregate Demand _Aggregate Supply long and run.pptErgin Akalpler
The document discusses aggregate demand and supply in the short and long run. It defines aggregate supply as the total output of goods and services supplied in an economy over time. In the short run, prices are fixed and aggregate supply is horizontal, so changes in aggregate demand lead to changes in output. In the long run, aggregate supply is vertical as output is determined by factor inputs, so changes in demand lead to changes in prices, not output. The document uses IS-LM and AD-AS models to explain fluctuations in the short run and how the economy adjusts in the long run.
CHAPTER 6 PART 1 BEEB2023 MACRO A221.pptxRahimahEmma
This document discusses equilibrium in the goods and money markets using IS-LM analysis. It begins by reviewing IS and LM curves and how they represent equilibrium. It then shows algebraically and graphically how to determine the equilibrium interest rate and level of income using the IS and LM curves. It analyzes how shifts in fiscal policy like government spending and taxes as well as monetary policy like money supply changes affect the curves and the equilibrium. It concludes by discussing how monetary and fiscal policies can be combined to increase output without raising interest rates.
Fiat value in the theory of value, by Edward C Prescott (Arizona State Univer...ADEMU_Project
Technology is rapidly advancing in the information processing area, which is changing the monetary/payment system. It's now technically feasible to have a currency–less monetary system; Professor Prescott explores such a system.
This presentation provides an overview of the goods market equilibrium and money market equilibrium using the IS-LM model. It defines the equilibrium conditions for the goods market as savings equaling investment, and for the money market as money supply equaling money demand. It derives the downward sloping IS curve and upward sloping LM curve, and explains how their intersection shows the overall equilibrium in the goods and money markets. The document then discusses how fiscal and monetary policies can shift the IS and LM curves and discusses the 2001 US recession within this framework.
This document provides an overview of macroeconomic analysis in an open economy context. It discusses exchange rate theories including PPP, UIP, and CIP. It also examines the advantages and disadvantages of fixed versus flexible exchange rate systems, and the impact of fiscal and monetary policy under each system. The document then presents the fundamental macroeconomic identity for an open economy and analyzes aggregate demand, the three macroeconomic gaps, and net exports. It also derives the relationship between net exports, investment-saving, and the exchange rate.
This document summarizes key aspects of economic policy under flexible exchange rates. It discusses how flexible exchange rates allow monetary policy to target domestic goals while fixed rates relinquish monetary control. Fiscal and monetary policies are examined, finding that fiscal policy is less effective if capital is mobile while monetary policy remains effective. Coordinating the two policies can help achieve multiple targets. The impacts of various exogenous shocks are also analyzed.
This lecture outline covers policy analysis using the IS-LM model, including monetary policy, fiscal policy, and their interaction. It discusses shocks to the model and the adjustment from the short-run to the long-run. Key topics include the effects of monetary and fiscal policy on output and interest rates, estimates of fiscal multipliers, and the derivation of the aggregate demand curve from the IS-LM model.
Persistent Slowdowns, Expectations and Macroeconomic PolicySuomen Pankki
This document provides an overview of Seppo Honkapohja's lecture on persistent slowdowns, expectations, and macroeconomic policy. The lecture discusses how recessions like the Great Recession can result in prolonged periods of low growth and interest rates near zero. It presents empirical data showing slow recoveries in the US, Japan, and Eurozone. The lecture then examines different modeling approaches to analyze economies stuck at the zero lower bound, including models based on rational and learning-based expectations. It focuses on analyzing dynamics using a New Keynesian model framework where private agents form expectations using steady-state learning. The lecture discusses how learning dynamics can result in multiple equilibrium states, including a stable high-inflation state and unstable low
This chapter discusses models of investment. It introduces the net present value model where firms invest if the discounted value of future cash flows exceeds costs. The accelerator model ties investment to changes in aggregate demand. The neoclassical model derives the desired capital stock based on profit maximization. It also examines Tobin's q ratio and complications like credit rationing. Policy tools discussed include investment tax credits and how corporate taxes treat debt versus equity financing.
This document provides an overview of consumption and savings concepts covered in an intermediate macroeconomics textbook chapter. It discusses the Keynesian consumption function, empirical studies of consumption, the life cycle hypothesis of consumption, expectations theories, the permanent income hypothesis, and recent empirical work. Key models of consumption behavior are outlined, including how consumption responds to temporary versus permanent changes in income based on the life cycle hypothesis.
1. This chapter discusses the demand for money based on three motives: transactions, precautionary, and speculative. It presents the standard money demand equation and explores each motive in more detail.
2. For the transactions motive, it uses examples to show how individuals and banks optimize their cash and deposit holdings based on transaction costs and interest rates. The Tobin-Baumol model is presented.
3. For the precautionary motive, it notes that money demand increases when uncertainty rises or interest rates on alternative assets fall. The speculative motive leads to more cash being held when risky asset returns fall or safe asset rates rise.
This document summarizes key topics in Chapter 8 of an Intermediate Macroeconomics textbook, including the classical theory of money, Keynesian and monetarist views of money supply, and the role of fiscal and monetary policy during the Great Depression. It discusses the quantity theory of money, assumptions around velocity and full employment, and how Keynes challenged the classical view. It also outlines Friedman's perspective on long and variable lags in policy and the debate around rules versus discretion. Historical data on money supply, stock prices, employment, and tax rates during the Depression are presented.
This document summarizes key concepts from Chapter 5 of an Intermediate Macroeconomics textbook on the Keynesian model. It introduces the simple Keynesian model and how it differs from classical macroeconomics in addressing recessions. It then covers aggregate expenditures, equilibrium, the consumption function, autonomous spending, solving for equilibrium using the autonomous spending multiplier, the effects of fiscal policy like government spending and taxes, and how automatic stabilizers counter economic fluctuations.
The document summarizes key concepts from an intermediate macroeconomics textbook chapter on long-run economic growth. It introduces growth accounting and examines the neoclassical and endogenous growth models. The neoclassical model shows output growing at the population rate unless productivity increases. The endogenous model explains productivity growth endogenously through constant or increasing returns to capital. Government policies that boost savings/investment or productivity can increase long-run growth rates.
This document introduces the equilibrium model in macroeconomics. It defines the equilibrium model as one where aggregate supply equals aggregate demand. It explains that the equilibrium model is solved by substituting equations into the aggregate demand function, setting it equal to output to find the equilibrium level, and simplifying. As an example, it presents a simple model where the equilibrium condition is that government spending plus transfers minus taxes must equal savings minus investment minus net exports. It then discusses implications like crowding out, Ricardian equivalence, and twin deficits that can result from changes in the government budget deficit in the model.
This document summarizes key concepts from an intermediate macroeconomics textbook chapter on measuring the macroeconomy. It discusses how gross domestic product (GDP) and gross national product (GNP) are used to measure total economic output. It also describes how GDP is calculated using expenditure and income approaches and how nominal and real GDP are distinguished. Finally, it discusses how price indexes like the GDP deflator and consumer price index (CPI) are used to measure inflation and compares their methodologies.
This document provides an overview of an intermediate macroeconomics textbook chapter. It introduces macroeconomics as the study of aggregate economic measures rather than individual agents. The main macroeconomic goals are outlined as low unemployment, price stability, and economic growth, which can sometimes conflict. Economic theory and models are discussed, emphasizing keeping models simple and using real rather than nominal values, per capita rather than total values, and growth rates rather than levels in empirical analysis.
This document discusses the selection of forging equipment and stock size for open and closed die forging. It begins by classifying forging equipment into work-restricted and stroke-restricted machines such as hammers, presses, and hydraulic presses. It then describes open and closed die forging processes and considerations for die design such as flash, gutter, draft angles, and variation of stroke with load. The document concludes by providing design considerations for blocker, finisher, trim tools, and punches.
This document discusses the selection of forging equipment and stock size for open and closed die forging. It begins by classifying forging equipment into work-restricted and stroke-restricted machines such as hammers, presses, and hydraulic presses. It then explains open and closed die forging processes and considerations for die design such as flash, gutter, draft angles, and variation of stroke with load. The document concludes by providing design considerations for blocker, finisher, trim tools, and punches.
5 Tips for Creating Standard Financial ReportsEasyReports
Well-crafted financial reports serve as vital tools for decision-making and transparency within an organization. By following the undermentioned tips, you can create standardized financial reports that effectively communicate your company's financial health and performance to stakeholders.
2. Elemental Economics - Mineral demand.pdfNeal Brewster
After this second you should be able to: Explain the main determinants of demand for any mineral product, and their relative importance; recognise and explain how demand for any product is likely to change with economic activity; recognise and explain the roles of technology and relative prices in influencing demand; be able to explain the differences between the rates of growth of demand for different products.
Abhay Bhutada Leads Poonawalla Fincorp To Record Low NPA And Unprecedented Gr...Vighnesh Shashtri
Under the leadership of Abhay Bhutada, Poonawalla Fincorp has achieved record-low Non-Performing Assets (NPA) and witnessed unprecedented growth. Bhutada's strategic vision and effective management have significantly enhanced the company's financial health, showcasing a robust performance in the financial sector. This achievement underscores the company's resilience and ability to thrive in a competitive market, setting a new benchmark for operational excellence in the industry.
STREETONOMICS: Exploring the Uncharted Territories of Informal Markets throug...sameer shah
Delve into the world of STREETONOMICS, where a team of 7 enthusiasts embarks on a journey to understand unorganized markets. By engaging with a coffee street vendor and crafting questionnaires, this project uncovers valuable insights into consumer behavior and market dynamics in informal settings."
3. Intermediate Macroeconomics
1. IS – LM Model
Introduce variable interest rate
Simple
Model
Chapter 4
Keynesian
Chapter 5
IS - LM
Chapter 6
Income Fixed Variable Variable
Interest Rates Fixed Fixed Variable
Prices Fixed Fixed Fixed
Consumption Autonomous
Function of
Income
Function of
Income
Investment Autonomous Autonomous
Function of
Interest Rate
Money Supply Not Included Not Included Autonomous
Money Demand Not Included Not Included
Function of
Income and
Interest Rate
4. Intermediate Macroeconomics
1. IS – LM Model
Introduce variable interest rate
• IS (Goods) Sector, Investment:
I = I0 - b · i
Solve for: iIS = f(Y)
• LM (Money) Sector, Money Demand:
Md = k · Y - h · i
Solve for: iLM = f(Y)
• Equilibrium
iIS = iLM
Solve for Y
5. Intermediate Macroeconomics
1. IS – LM Model
IS – LM Curves
0
0. 02
0. 04
0. 06
0. 08
0. 1
0. 12
0 2 4 6 8 10 12 14 16 18 20
National Income, Y
InterestRate,i
IS Curve
LM Curve
Equilibrium Income
and Interest Rate
6. Intermediate Macroeconomics
1. IS – LM Model
Fiscal and monetary policy
• Fiscal Policy (spending and taxes)
– shifts IS curve
– increase in spending or cut in taxes
shifts IS curve to the right
• Monetary Policy (money supply)
– shifts LM curve
– increase in money supply shifts LM
curve to the right
7. Intermediate Macroeconomics
2. IS curve
Investment
0
0.02
0.04
0.06
0.08
0.1
0.12
0 2 4 6 8 10 12 14 16 18
Planned Investment
InterestRate
Planned investment is a negative
function of the interest rate
Slope = - b
As the interest rate declines
planned investment increases.
8. Intermediate Macroeconomics
2. IS Curve
The “goods” market
Given:
AE = C + I + G + NX
C = C0 + c · YD
I = I0 - b · i
G = G0
NX = NX0
YD = Y – t · Y + TR0
9. Intermediate Macroeconomics
2. IS Curve
Derive the IS curve (1 of 3)
• Given:
AE = C + I + G + NX
C = C0 + c · YD
I = I0 - b · i
G = G0
NX = 0
YD = Y – T0 – t · Y + TR
• Step 1. Restate Aggregate Demand:
AE = C0 + c · (Y – T0 – t · Y + TR) + I0 - b · i + G0
10. Intermediate Macroeconomics
2. IS Curve
Derive the IS curve (2 of 3)
Step 2. State the Goods Market equilibrium
condition:
Y = AE
Step 3. Substitute AE from Step 1 into Step 2:
Y = C0 + c · (Y – T0 – t · Y + TR) + I0 - b · i + G0
11. Intermediate Macroeconomics
2. IS Curve
Derive the IS curve (3 of 3)
Step 4. Solve for Interest Rate as a function of
Income:
Y = C0 + c · (Y – T0 – t · Y + TR) + I0 - b · i + G0
b · i = C0 + I0 + G0 + c · (Y – T0 – t · Y + TR) - Y
b · i = C0 + I0 + G0 – T0 + c · TR – [1 – c(1-t)] · Y
i = 1 · (C0 + I0 + G0 – c · T0 + c · TR) - 1- c(1-t) · Y
b b
intercept slope
(negative)
12. Intermediate Macroeconomics
2. IS Curve
Graph
0
0.05
0.1
0.1 5
0.2
0.2 5
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8
National Income, Y
InterestRate,i
Intercept = 1 * (C0 + I0 + G0 - c T0 + c TR)
b
Slope = - 1 - c (1 - t)
b
13. Intermediate Macroeconomics
2. IS Curve
Shift in the IS curve
A change in the intercept causes the IS curve
to shift.
Intercept = 1 * (C0 + I0 + G0 - c T0 + c TR)
b
An increase in government spending or
decrease in taxes increases the value of the
intercept and causes the IS curve to shift up
(or to the right).
The size of the shift depends on the sensitivity
of investment to the interest rate, b.
14. Intermediate Macroeconomics
2. IS Curve
Fiscal policy effectiveness and IS curve shift
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0.1 4
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
IS Curve
LM Curve
Small shift in IS Curve.
b is large.
Investment is very sensitive to
changes in the interest rate
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0.1 4
0.1 6
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
LM Curve
IS Curve
Large shift in IS Curve.
b is small.
Investment is not sensitive to
changes in the interest rate
15. Intermediate Macroeconomics
2. IS Curve
Fiscal policy effectiveness and IS curve shift
• Small shift in IS curve
– Classical view, fiscal policy ineffective
– Increase in government spending raises
interest rate, which crowds out (reduces)
investment spending. Net increase in
aggregate spending may be small
• Large shift in IS curve
– Keynesian view, fiscal policy effective.
– Increase in government spending may raise
the interest rate but has no effect on
investment. Get big bang for buck.
16. Intermediate Macroeconomics
2. IS Curve
Slope of the curve
Effectiveness of fiscal policy also
depends on the slope of the IS curve
Slope = - 1 - c (1 - t)
b
Keynesian: small b, steep curve
fiscal policy more effective
Classical: large b, flat curve
fiscal policy less effective
17. Intermediate Macroeconomics
2. IS Curve
Fiscal policy effectiveness and IS curve slope
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
IS Curve
LM Curve
Flat IS Curve.
b is large.
Investment is very sensitive to
changes in the interest rate
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
LM Curve
IS Curve
Steep IS Curve.
b is small.
Investment is not sensitive to
changes in the interest rate
Small increase in
National Income
Larger increase in
National Income
18. Intermediate Macroeconomics
2. IS Curve
Fiscal policy effectiveness and IS curve slope
• Flat IS curve
– Classical view, fiscal policy ineffective
– Increase in government spending raises
interest rate, which crowds out (reduces)
investment spending. Net increase in
aggregate spending may be small
• Steep IS curve
– Keynesian view, fiscal policy effective.
– Increase in government spending may raise
the interest rate but has little effect on
investment. Get big bang for buck.
19. Intermediate Macroeconomics
3. LM Curve
Money Supply and Money Demand
• Money Supply:
– assumed to be a some fixed level
• Money Demand:
– negative function of interest rate. People
hold more money when interest rates
decline.
– positive function of income. People hold
more money as their income increases.
20. Intermediate Macroeconomics
3. LM Curve
Derive the LM Curve (1 of 2)
• Given:
Money Demand: Md = k · Y - h · i
Money Supply: Ms = M
• Step 1. State the money market equilibrium
condition:
Ms = Md
• Step 2. Substitute equations for Md and Ms
into equilibrium condition:
M = k · Y - h · i
21. Intermediate Macroeconomics
3. LM Curve
Derive the LM Curve (2 of 2)
Step 3. Solve for Interest Rate as a
function of Income:
M = k · Y - h · i
h · i = - M + k · Y
i = - 1 · M + k · Y
h h
intercept slope
(positive)
22. Intermediate Macroeconomics
3. LM Curve
Graph
-0.04
-0.02
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0.1 4
0.1 6
0.1 8
2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
Intercept = - 1 M
h
Slope = k
h
23. Intermediate Macroeconomics
3. LM Curve
Shift in the LM curve
A change in the intercept causes the LM curve
to shift.
Intercept = - 1 M
h
An increase in money supply, M, reduces the
value of the intercept (more negative) and
causes the LM curve to shift down (or to the
right).
The size of the shift depends on the sensitivity
of money demand to the interest rate, h.
24. Intermediate Macroeconomics
3. LM Curve
Monetary policy and LM curve shift
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
IS Curve
LM Curve
Small shift in LM Curve.
h is large.
Money demand is very sensitive to
changes in the interest rate
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
LM Curve
IS Curve
Large shift in LM Curve.
h is small.
Large change in interest rate
required to change money demand
25. Intermediate Macroeconomics
3. LM Curve
Monetary policy and LM curve shift
• Small shift in LM curve
– Keynesian view, monetary policy ineffective
– Increase in money supply is met by an
increase in money demand without a
significant decline in the interest rate. No
stimulus to investment spending.
• Large shift in LM curve
– Classical view, monetary policy effective.
– Increase in money supply leads to a large
decline in the interest rate in order to increase
money demand. Increases investment
spending.
26. Intermediate Macroeconomics
3. LM Curve
Slope of the LM curve
Effectiveness of monetary policy also depends
on the slope of the LM curve
Slope = k
h
Keynesian: large h, flat curve
monetary policy less effective
Classical: small h, steep curve
monetary policy more effective
Note: little debate over change in money
demand with change in income, k.
27. Intermediate Macroeconomics
3. LM Curve
Monetary policy and LM curve slope
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
IS Curve
LM Curve
Steep LM Curve.
h is small.
Money demand is insensitive to
changes in the interest rate
0
0.02
0.04
0.06
0.08
0 .1
0.1 2
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
LM Curve
IS Curve
Flat LM Curve.
h is large.
Money demand is very sensitive
to changes in the interest rate
Smaller increase in
National Income
28. Intermediate Macroeconomics
3. LM Curve
Monetary policy and LM curve slope
• Flat LM curve
– Keynesian view, monetary policy ineffective
– Increase in money supply has little or no effect
on the interest rate. Money demand adjusts to
match money supply. No change in interest
rate means no change in investment and
aggregate spending
• Steep LM curve
– Classical view, monetary policy effective.
– Increase in money supply lowers the interest
rate, which increases investment spending.
29. Intermediate Macroeconomics
4. IS - LM Equilibrium
Solve the model (1 of 2)
Step 1. Apply IS - LM equilibrium condition
iIS = iLM
Step 2. Substitute IS (step 4) and LM (step 3)
solutions for interest rate:
1 · (C0 + I0 + G0 + c · TR – c · T0) - 1 – c(1-t) · Y
b b
= - 1 · M + k · Y
h h
30. Intermediate Macroeconomics
4. IS - LM Equilibrium
Solve the model (2 of 2)
Step 3. Solve for Income, Y
Y = h (C0 + I0 + G0 + c · TR – c · T0)
[1-c(1-t)] · h + b · k
+ b M
[1-c(1-t)] · h + b · k
Autonomous
Spending Money
Multiplier Multiplier
31. Intermediate Macroeconomics
5. Fiscal and Monetary Policy
Fiscal Policy
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
IS Curve
LM Curve
1
2
1 – Increase in government spending (expansionary fiscal policy)
National income rises with increase in spending (C and G)
2 – Increase in income leads to increase in money demand.
Interest rate rises to maintain balance between money
supply and money demand.
Investment spending declines with higher interest rate.
Aggregate spending and national income decline.
32. Intermediate Macroeconomics
5. Fiscal and Monetary Policy
Monetary Policy
0
0.02
0.04
0.06
0.08
0.1
0.1 2
0 2 4 6 8 1 0 1 2 1 4 1 6 1 8 2 0
National Income, Y
InterestRate,i
IS Curve
LM Curve
1
2
1 – increase in money supply (expansionary monetary policy).
interest rate falls to maintain balance between money
demand and money supply.
2 – lower interest rate stimulates investment spending.
increase in national income with higher spending also
raises money demand which leads to an increase
in the interest rate.
33. Intermediate Macroeconomics
5. Fiscal and Monetary Policy
Expansionary fiscal policy
• Investment negatively related to interest rate (investment
curve downward sloping)
• Aggregate expenditures negatively related to interest rate
(downward sloping)
• Fiscal policy change shifts the IS curve only. Increase in
government spending or cut in taxes shifts IS curve to the
right
Keynes Classical
Investment and
interest rate
Insensitive (inelastic)
b is small
Sensitive (elastic)
b is large
IS curve intercept
shift, 1/b
Large Small
IS curve slope,
- [1-c(1-t)]/b
Steep Flat
Crowding out of
investment
Small Large
34. Intermediate Macroeconomics
5. Fiscal and Monetary Policy Summary
Expansionary monetary policy
• Money demand negatively related to interest rate and
positively related to income
• LM curve upward sloping. An increase in income requires
an increase in interest rate to maintain constant money
demand.
• Monetary policy change shifts the LM curve only. Increase
in money supply shifts LM curve to the right
Keynes Classical
Money demand
and interest rate
Sensitive (elastic)
h is large
Insensitive (inelastic)
h is small
LM curve intercept
shift, 1/h
Small Large
IS curve slope,
k/h
Flat Steep
Change in
investment
Small Large