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Economics: A Contemporary Introduction
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Chapter 29 / Exercise 13
Economics: A Contemporary Introduction
McEachern
Expert Verified
of 42Chapter 9IS-LM Model1
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Economics: A Contemporary Introduction
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Chapter 29 / Exercise 13
Economics: A Contemporary Introduction
McEachern
Expert Verified
of 421) What is the IS curve?2) How do changes in interest rates affect the equilibrium level of production and income in a sticky-price model?3) What determines the money market equilibrium with sticky prices?4) What is the LM curve?5) What is an IS shock?6) What is an LM shock?7) What is the IS-LM equilibrium? 8) How do different shocks affect the IS-LM equilibrium?Questions2
of 423
of 42A higher interest rate reduces autonomous spending (A) by reducing investment (Irr)A higher interest rate also reduces autonomous spending (A) by reducing net exports •Recall ε = ε0 − εr(r − rf)Hence, when r increases ε falls, reducing net exportsIn chapter 8, we keep r as given and fixed. Now we see that r plays an important role in the determination of the equilibrium.Aggregate Demand: Autonomous Spending4)εX+Y(X+G+r)×I-I(+C=Aεffr00r)X(I-)]rXXY(XGIC[Arrfrff00εεεεεε0
of 42Aggregate Demand: Autonomous Spending5
of 42Because a change in the real interest rate changes autonomous spending, it will change the equilibrium level of real GDPthe effect will be equal to the interest sensitivity of autonomous spending (Ir+ Xεεr) times the multiplierIS curveThe relationship between the level of the real interest rate and the equilibrium level of real GDPInvestment-Saving (IS) Curve 6r)X(I-)]rXXY(XGIC[Arrfrff00εεεεεε0
of 42IS Curve 7
of 42•Define baseline autonomous spending(A0) to include the determinants of autonomous spending that do not depend on the real interest rate)]
IS Curve: Equation 8r)X(I-)]rXXY(XGIC[Arrfrff00εεεεεε0
of 42The term on the left is the horizontal intercept of the IS curveThe term on the right is measures the responsiveness of real GDP to changes in the interest rateSince r is on the y-axis, the slope of the IS curve given by:IS Curve: Equation 9r)IM-t)-(1(C-1)X(I-)IM-t)-(1(C-1)]rXXY(XGI[CYyyrryyfrff00εεεεεε0Y)X(I)IM-t)-(1(C-1-)X(I)]rXXY(XGI[Crrryyrrfr0ff00εεεεεεεε
of 42IS Curve: Graph 10The IS curve plots for each rthe corresponding Ythat is consistent with equilibrium in the goods marketThe IS curve plots for each rthe corresponding Ythat is consistent with equilibrium in the goods market

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