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• The important assumption: the economy is closed.
The IS curve: equilibrium in the goods and services market
• Figure1 Deriving thewenku.baidu.comIS curve:
S1:Y=4000 S2:Y=5000
12
SHORT-RUN ECONOMIC FLUCTUATIONS
Part1: IS-LM Model and AD-AS Model
33
The origin of IS-LM model
• IS-LM model is about the simultaneously equilibriums of goods (services) markets and asset market.
Taxes, T
MPK
Expected tax rate on capital
Shifts the IS curve
Up
Up
Up
No change or down
？ ？
Reason
S↓(C↑), r↑
S↓(C↑), r↑ S↓ (demand for goods↑), r↑
No change: Ricardian equivalence Down: no R.E.，C↓, S↑, r↓
Real interest rate, r Real interest rate ,r
D
7%
5%
F
D
7%
F
5%
I
Saving, S; Investment, I
IS
4000 5000 Output, Y
The IS curve: equilibrium in the goods and services market
The IS curve: equilibrium in the goods and services market
• Factors that shift the IS curve:
An increase in
Expected future output
Wealth
Government purchases, G
• I: Investment; • S: Saving; • L: Money demanded; • M: Money supplied.
• The IS-LM model was developed in 1937 by Nobel laureate John Hicks, who intended it as a graphical representation of the ideas of Keynes.
• In general, because a rise in output increases desired national saving, thereby reducing the real interest rate that clears the goods market, the IS curve slopes downward.
C A
7%
B
5%
Real money demand, MD(Y=5000)
MD(Y=4000) Real money supply,M/P, Real money demand Md /P
• In the left-hand side, it is a determined process of real interest rate and money demanded.
• In this process, a change of output Y brings a corresponding shift of saving curve, which then result in a new equilibrium.
…… ……
The IS curve: equilibrium in the goods and services market
• Figure2 Effect on the IS curve of a temporary increase in
government purchases:
Real interest rate, r Real interest rate ,r
The IS curve: equilibrium in the goods and services market
• The implication of IS curve: IS curve shows the real interest rate, r, for which the goods market is in equilibrium; so, at all points on the IS curve desired investment equals desired national saving.
The LM curve: Asset market equilibrium
• Figure3 Deriving the LM curve: assumption---P constant
Real money supply, MS
LM
Real interest rate, r Real interest rate ,r
S2
S1
Increase in G
F
F
7%
E
E
6%
I
Saving, S; Investment, I
IS2 IS1
4500 Output, Y
The IS curve: equilibrium in the goods and services market
• In summary, for constant output, any change in the economy that reduces desired national saving relative to desired investment will increase the real interest rate that clears the goods market and thus shift the IS curve up.
The IS curve: equilibrium in the goods and services market
• Figure1 Deriving thewenku.baidu.comIS curve:
S1:Y=4000 S2:Y=5000
12
SHORT-RUN ECONOMIC FLUCTUATIONS
Part1: IS-LM Model and AD-AS Model
33
The origin of IS-LM model
• IS-LM model is about the simultaneously equilibriums of goods (services) markets and asset market.
Taxes, T
MPK
Expected tax rate on capital
Shifts the IS curve
Up
Up
Up
No change or down
？ ？
Reason
S↓(C↑), r↑
S↓(C↑), r↑ S↓ (demand for goods↑), r↑
No change: Ricardian equivalence Down: no R.E.，C↓, S↑, r↓
Real interest rate, r Real interest rate ,r
D
7%
5%
F
D
7%
F
5%
I
Saving, S; Investment, I
IS
4000 5000 Output, Y
The IS curve: equilibrium in the goods and services market
The IS curve: equilibrium in the goods and services market
• Factors that shift the IS curve:
An increase in
Expected future output
Wealth
Government purchases, G
• I: Investment; • S: Saving; • L: Money demanded; • M: Money supplied.
• The IS-LM model was developed in 1937 by Nobel laureate John Hicks, who intended it as a graphical representation of the ideas of Keynes.
• In general, because a rise in output increases desired national saving, thereby reducing the real interest rate that clears the goods market, the IS curve slopes downward.
C A
7%
B
5%
Real money demand, MD(Y=5000)
MD(Y=4000) Real money supply,M/P, Real money demand Md /P
• In the left-hand side, it is a determined process of real interest rate and money demanded.
• In this process, a change of output Y brings a corresponding shift of saving curve, which then result in a new equilibrium.
…… ……
The IS curve: equilibrium in the goods and services market
• Figure2 Effect on the IS curve of a temporary increase in
government purchases:
Real interest rate, r Real interest rate ,r
The IS curve: equilibrium in the goods and services market
• The implication of IS curve: IS curve shows the real interest rate, r, for which the goods market is in equilibrium; so, at all points on the IS curve desired investment equals desired national saving.
The LM curve: Asset market equilibrium
• Figure3 Deriving the LM curve: assumption---P constant
Real money supply, MS
LM
Real interest rate, r Real interest rate ,r
S2
S1
Increase in G
F
F
7%
E
E
6%
I
Saving, S; Investment, I
IS2 IS1
4500 Output, Y
The IS curve: equilibrium in the goods and services market
• In summary, for constant output, any change in the economy that reduces desired national saving relative to desired investment will increase the real interest rate that clears the goods market and thus shift the IS curve up.