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Econ 232HChapter 11 Reading Notes
Explaining Functions with the ISLM model
How fiscal policy shifts the IS curve and changes the short run equilibrium
•
Increase in gov’t purchases 1) shifts IS curve right by (Delta G)/(1MPC), 2)
Which raises income 3) And the interest rate
•
Changes in taxes. IS curve shifts to right by (delta T)/(MPC/(1MPC)), which
raises income and interest rate.
•
Increase in MS shifts the LM curve downward, raises income, and lowers interest
rate.
•
An increase in the MS lowers interest rate, which stimulates investment and
expands the demand for G and S.
Interaction between monetary and fiscal policy
•
Fed holds money supply constant 1) Tax increase shifts the IS curve, but the fed
holds the MS constant, the LM curve stays the same.
•
Fed holds int rate constant; a tax increase shifts the IS curve and to hold the int.
rate constant, the fed contracts the money supply.
•
A tax increase shifts the IS curve, and to hold income constant, the Fed expands
the MS.
ISLM as a Theory of Aggregate Demand
•
A higher price level P shifts the LM curve upward, lowering income Y, the AD
curve summarizes the relationship between P and Y.
•
A change in income in the ISLM Model resulting from a change in the price
level represents a movement along the aggregate demand curve. A change in
income in the ISLM model for a give price level presresents a shift in the
aggregate demand curve.
•
Expansionary monetary policy: monetary expansion shifts the LM curve,
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 Spring '08
 Li
 Fiscal Policy, ISLM Model

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