Chpt 9 Review - (Part 2)

# Chpt 9 Review - (Part 2) - Chapter 9: A Quick Review Note:...

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1 Chapter 9: A Quick Review Note: This is just a quick review on the IS-LM-FE diagram. See the lecture notes and the textbook chapter for more details. In the economy, there are 3 major markets: the labor market, the goods market and the asset market. When all 3 markets are in equilibrium at the same time, it is called a general equilibrium. The general equilibrium situation can be summarized by the IS-LM-FE diagram. IS-LM-FE Diagram In this diagram, the FE line represents the labor market equilibrium , the IS curve represents the goods market equilibrium and the LM curve represents the asset market equilibrium. (1) Goods Market Equilibrium (IS curve) In Chapter 4, we learned that the goods market equilibrium is determined by the intersection of the saving curve and the investment curve . Recall that real output (or real income, represented by Y) is one of the factors that shift the saving curve. An increase in real (current) income would induce people to save more. This shifts the saving curve to the right from S 1 to S 2 . The new equilibrium in the goods market is now represented by point F in the diagram. Real interest rate is lowered in the new equilibrium. This means when real output (Y) increases, the real interest rate has to be lowered in order to keep the goods market in equilibrium . This negative relationship between real output and real interest rate is represented by the IS curve. F S 1 S 2 Saving, Investment I Real interest rate Y Goods Market Equilibrium Real output IS curve Real interest rate

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2 Now suppose the expected future marginal product of capital increases (the entire MPK f curve shifts up) which encourages firms to invest more. The investment curve shifts up and to the right as a result but the saving curve is not affected. How does this affect the IS curve ? Suppose the goods market is in equilibrium before the change and the initial equilibrium
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## This note was uploaded on 08/11/2008 for the course ECON 103a taught by Professor Suen during the Winter '08 term at UC Riverside.

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Chpt 9 Review - (Part 2) - Chapter 9: A Quick Review Note:...

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