Topic5_1_The_IS-LM_Model - ECON 303 Intermediate Economic Theory Macroeconomics I Topic 5 Goods and Financial Markets The IS-LM Model Muna Esheba

Topic5_1_The_IS-LM_Model - ECON 303 Intermediate...

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ECON 303: Intermediate Economic Theory Macroeconomics I Topic 5: Goods and Financial Markets: The IS-LM Model Muna Esheba September 26, 2019
Learning Objectives By the end of this lecture, you will learn I Equilibrium in the goods market I Equilibrium in financial markets I Equilibrium in both goods and financial markets. Back Esheba (U of C) The IS-LM Model September 26, 2019 1 / 26
Outline I Equilibrium in the Goods Market: The IS Relation I Equilibrium in Financial Markets: The LM Relation I The IS - LM Model I Summary I Reading Assignment I Next Topic Esheba (U of C) The IS-LM Model September 26, 2019 2 / 26
Equilibrium in the Goods Market Let’s first summarize what we learned in the goods market: I The demand for goods (Z) is given by Z = C + I + G I Assumptions: I Consumption was a function of disposable income ( Y D ) C = C ( Y D ) C = C ( Y - T ) I Exports, imports, and net exports were zero I T , I , and G are given I The interest rate did not affect the demand for goods I The goods market equilibrium condition: Y = Z ⇐⇒ I = S + ( T - G ) Y = Z = Y = C ( Y - ¯ T ) + ¯ I + ¯ G I Changes in C , I and G cause changes in equilibrium Y. Esheba (U of C) The IS-LM Model September 26, 2019 3 / 26
Equilibrium in the Goods Market I Investment ( I ) depends on two factors: I The level of sales ( Y ) I We assume that sales and production are equal and inventory investment equals zero I The interest rate ( i ) I The investment relation can be written as follows I = I ( Y , i ) (+ , - ) I More sales encourage investment, Y → ↑ I I A higher interest rate, discourages investment, i → ↓ I Esheba (U of C) The IS-LM Model September 26, 2019 4 / 26
Equilibrium in the Goods Market I The equilibrium condition in the goods market becomes: Y = C ( Y - T ) + I ( Y , i ) + G The supply of goods

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