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IS-LM MODEL Presentation Transcript
1.IS-LM MODEL
2.IS/LM Model
The IS/LM model, first developed by Sir John Hicks and Alvin Hansen in 1937 to summarize John Maynard Keynes’ General Theory of Employment, Interest, and Money.
The horizontal axis represents national income or real gross domestic product and is labeled Y. The vertical axis represents the interest rate, r. The graph thus represents the interface between the “real” and the “monetary” parts of the economy.
The point where these schedules intersect represents a short-run equilibrium in the real and monetary sectors (though not necessarily in other sectors, such as labor markets). In IS/LM equilibrium, both product markets and money markets are in equilibrium. Both the interest rates and real GDP are determined.
3.IS/LM Model
The IS schedule is drawn as a downward-sloping curve because a decrease in interest rates will rise the planned fixed investment and ultimately rising national income and output.
IS stand for “Investment-Saving Equilibrium” to illustrate the real or non-financial economy (goods or product market), where total spending (Consumer spending + planned private investment + Government purchases + net exports) equals an economy’s total output and income.
IS curve represents the equilibrium where total private investment equals total saving. Where total saving equals consumer saving plus government saving (the budget surplus) plus foreign saving (the trade surplus). All spending is desired or planned; there is no unplanned inventory accumulation.
4.IS/LM Model
The IS schedule is drawn as a downward-sloping curve because a decrease in interest rates will rise the planned fixed investment and ultimately rising national income and output.
IS stand for “Investment-Saving Equilibrium” to illustrate the real or non-financial economy (goods or product market), where total spending (Consumer spending + planned private investment + Government purchases + net exports) equals an economy’s total output and income.
IS curve represents the equilibrium where total private investment equals total saving. Where total saving equals consumer saving plus government saving (the budget surplus) plus foreign saving (the trade surplus). All spending is desired or planned; there is no unplanned inventory accumulation.
5.Product Market equilibrium: The Demand for Goods
The IS/LM model, first developed by Sir John Hicks and Alvin Hansen in 1937 to summarize John Maynard Keynes’ General Theory of Employment, Interest, and Money.
The horizontal axis represents national income or real gross domestic product and is labeled Y. The vertical axis represents the interest rate, r. The graph thus represents the interface between the “real” and the “monetary” parts of the economy.
The point where these schedules intersect represents a short-run equilibrium in the real and monetary sectors (though not necessarily in other sectors, such as labor markets). In IS/LM equilibrium, both product markets and money markets are in equilibrium. Both the interest rates and real GDP are determined.
3.IS/LM Model
The IS schedule is drawn as a downward-sloping curve because a decrease in interest rates will rise the planned fixed investment and ultimately rising national income and output.
IS stand for “Investment-Saving Equilibrium” to illustrate the real or non-financial economy (goods or product market), where total spending (Consumer spending + planned private investment + Government purchases + net exports) equals an economy’s total output and income.
IS curve represents the equilibrium where total private investment equals total saving. Where total saving equals consumer saving plus government saving (the budget surplus) plus foreign saving (the trade surplus). All spending is desired or planned; there is no unplanned inventory accumulation.
4.IS/LM Model
The IS schedule is drawn as a downward-sloping curve because a decrease in interest rates will rise the planned fixed investment and ultimately rising national income and output.
IS stand for “Investment-Saving Equilibrium” to illustrate the real or non-financial economy (goods or product market), where total spending (Consumer spending + planned private investment + Government purchases + net exports) equals an economy’s total output and income.
IS curve represents the equilibrium where total private investment equals total saving. Where total saving equals consumer saving plus government saving (the budget surplus) plus foreign saving (the trade surplus). All spending is desired or planned; there is no unplanned inventory accumulation.
5.Product Market equilibrium: The Demand for Goods
6.Consumption (C)
7.A more specific form of the consumption function is this linear relation:
8.Consumption (C)
9.Investment (I)
10.Government Spending (G)
Government spending, G, together with taxes, T, describe fiscal policy—the choice of taxes and spending by the government.
We shall assume that G and T are also exogenous.
Government spending, G, together with taxes, T, describe fiscal policy—the choice of taxes and spending by the government.
We shall assume that G and T are also exogenous.
11.Demand, production and income
12.Using Algebra
13.Using a Graph
14.The Determination of Equilibrium Output
15.The Determination of Output
16.Deriving the IS Curve
17.IS curve
18.Deriving the IS curve
19.Shifting the IS curve:G
20.Shifts of the IS Curve
21.IS Curve
An increase in interest rates will only cause an upward movement along the IS curve.
IT DOES NOT cause a shift in the IS curve.
An increase in interest rates will only cause an upward movement along the IS curve.
IT DOES NOT cause a shift in the IS curve.
22.The IS curve and the Loanable Funds model
23.Question
What would happen if government expenditures would increase?
What would happen if government expenditures would increase?
24.Understanding the IS curve’s slope
The IS curve is negatively sloped.
Intuition: A fall in the interest rate motivates firms to increase investment spending, which drives up total planned spending (E ).
To restore equilibrium in the goods market, output (a.k.a. actual expenditure, Y ) must increase.
The IS curve is negatively sloped.
Intuition: A fall in the interest rate motivates firms to increase investment spending, which drives up total planned spending (E ).
To restore equilibrium in the goods market, output (a.k.a. actual expenditure, Y ) must increase.
25.Major Criticisms of IS model
One of the major criticisms of deficit spending as a way to stimulate the economy: rising interest rates lead to crowding out – i.e., discouragement – of private fixed investment, which in turn may hurt long-term growth of the supply side (potential output).
Keynesians respond that deficit spending may actually “crowd in” (encourage) private fixed investment via the accelerator effect, which helps long-term growth. Further, if government deficits are spent on productive public investment (e.g., infrastructure or public health) that directly and eventually raises potential output.
One of the major criticisms of deficit spending as a way to stimulate the economy: rising interest rates lead to crowding out – i.e., discouragement – of private fixed investment, which in turn may hurt long-term growth of the supply side (potential output).
Keynesians respond that deficit spending may actually “crowd in” (encourage) private fixed investment via the accelerator effect, which helps long-term growth. Further, if government deficits are spent on productive public investment (e.g., infrastructure or public health) that directly and eventually raises potential output.
26.Financial Markets and the LM Relation
27.Money Supply
28.Money Demand
29.Equilibrium
30.Real Money, Real Income, and the Interest Rate
31.Understanding the LM curve’s slope
The LM curve is positively sloped.
Intuition: An increase in income raises money demand.
Since the supply of real balances is fixed, there is now excess demand in the money market at the initial interest rate.
The interest rate must rise to restore equilibrium in the money market.
The LM curve is positively sloped.
Intuition: An increase in income raises money demand.
Since the supply of real balances is fixed, there is now excess demand in the money market at the initial interest rate.
The interest rate must rise to restore equilibrium in the money market.
32.Deriving the LM Curve
33.Deriving the LM Curve
34.The LM curve
35.Deriving the LM curve
36.Goods and Financial markets Equilibrium
37.IS – LM model
Equilibrium on the goods market and on the financial market
Find (i,Y) such that both markets are in equilibrium
IS: Combination of i and Y such that the goods market is in equilibrium
LM: Combination of i and Y such that the financial market is in equilibrium
Equilibrium on the goods market and on the financial market
Find (i,Y) such that both markets are in equilibrium
IS: Combination of i and Y such that the goods market is in equilibrium
LM: Combination of i and Y such that the financial market is in equilibrium
38.Putting the IS and the LM Relations Together
39.The short-run equilibrium
40.IS - LM
41.Fiscal Policy, Activity, and the Interest Rate
Fiscal contraction or Fiscal consolidation
Fiscal expansion.
affects the IS curve, not the LM curve.
Fiscal contraction or Fiscal consolidation
Fiscal expansion.
affects the IS curve, not the LM curve.
42.Fiscal Policy, Activity, and the Interest Rate
43.Monetary Policy, Activity, and the Interest Rate
Monetary contraction, or monetary tightening
Monetary expansion.
Monetary contraction, or monetary tightening
Monetary expansion.
44.Monetary Policy, Activity, and the Interest Rate
45.Monetary and Fiscal policies
Monetary Policy: M, shifts the LM curve
Fiscal Policy: T,G, shifts the IS curve
Monetary Policy: M, shifts the LM curve
Fiscal Policy: T,G, shifts the IS curve
46.Using a Policy Mix
47.The Clinton-Greenspan Policy Mix
48.The Clinton-Greenspan Policy Mix
49.German Unification and the German Monetary-Fiscal Tug of War
50.German Unification and the German Monetary-Fiscal Tug of War
51.The IS curve
52.Fiscal Policy and the IS curve
We can use the IS-LM model to see how fiscal policy (G and T ) can affect aggregate demand and output.
Let’s start by using the Keynesian Cross to see how fiscal policy shifts the IS curve…
We can use the IS-LM model to see how fiscal policy (G and T ) can affect aggregate demand and output.
Let’s start by using the Keynesian Cross to see how fiscal policy shifts the IS curve…
53.The Theory of Liquidity Preference
due to John Maynard Keynes.
A simple theory in which the interest rate is determined by money supply and money demand.
due to John Maynard Keynes.
A simple theory in which the interest rate is determined by money supply and money demand.
54.How the Fed raises the interest rate
55.CASE STUDY Volcker’s Monetary Tightening
56.Volcker’s Monetary Tightening,
57.The Big Picture
58.Chapter summary
Keynesian Cross
basic model of income determination
takes fiscal policy & investment as exogenous
fiscal policy has a multiplied impact on income.
IS curve
comes from Keynesian Cross when planned investment depends negatively on interest rate
shows all combinations of r and Y that equate planned expenditure with actual expenditure on goods & services
59.Theory of Liquidity Preference
basic model of interest rate determination
takes money supply & price level as exogenous
an increase in the money supply lowers the interest rate
LM curve
comes from Liquidity Preference Theory when money demand depends positively on income
shows all combinations of r andY that equate demand for real money balances with supply
Keynesian Cross
basic model of income determination
takes fiscal policy & investment as exogenous
fiscal policy has a multiplied impact on income.
IS curve
comes from Keynesian Cross when planned investment depends negatively on interest rate
shows all combinations of r and Y that equate planned expenditure with actual expenditure on goods & services
59.Theory of Liquidity Preference
basic model of interest rate determination
takes money supply & price level as exogenous
an increase in the money supply lowers the interest rate
LM curve
comes from Liquidity Preference Theory when money demand depends positively on income
shows all combinations of r andY that equate demand for real money balances with supply
60.Fiscal Policy, Activity, and the Interest Rate
61.Monetary Policy, Activity, and the Interest Rate
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