Lecture 8 - 1 of 42 Chapter 9 IS-LM Model 2 of 42 Questions...

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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 εfalls, 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[Arrfrff000
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+ Xr) 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[Arrfrff000
of 42IS Curve 7
of 42Define 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[Arrfrff000
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[CYyyrryyfrff000Y)X(I)IM-t)-(1(C-1-)X(I)]rXXY(XGI[Crrryyrrfr0ff00
of 42IS Curve: Graph 10The IS curve plots for each rthe corresponding Ythat is consistent with equilibrium in the goods market
of 42The first term is the inverse of the multiplier (1/1-MPE)The second term shows how large a change in investment or exports is generated by a change in the real interest rateIS Curve: Slope 11)εX+(IMPE-1-=)εX+(I)IM-t)-(1(C-1-=slopeISrεrrεryy
of 42The position of the IS curve depends on the baseline level of autonomous spending times the multiplier

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