Lesson_64_IS-LM - IS-LM An increase in income tends to...

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1 Lesson 64 1 IS-LM An increase in income tends to increase the interest rate But an increase in the interest rate tends to reduce income How to get out of this circular reasoning? This lesson shows how equilibrium interest rate and income determined simultaneously Lesson 64 2 From earlier lesson: Y ( ) () NS Y I CA Y ( ) , CA E Y ( ) NS Y I Lesson 64 3 Allow investment to depend on interest rate Y ( ) ( ) NS Y I i CA Y ( ) , CA E Y ( ) ( ) 1 NS Y I i
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2 Lesson 64 4 Investment falls when i increases: Y ( ) ( ) () NS Y I i CA Y ( ) , CA E Y ( ) ( ) 1 NS Y I i ( ) ( ) 2 NS Y I i 21 ii > Lesson 64 5 As such, equilibrium income falls Y ( ) ( ) NS Y I i CA Y ( ) , CA E Y ( ) ( ) 1 NS Y I i ( ) ( ) 2 NS Y I i Lesson 64 6 We can illustrate relationship with IS curve: all combinations of i and Y such that CA = NS - I Y i IS
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3 Lesson 64 7 IS curve drawn holding all other things constant Y i IS Lesson 64 8 Among those things being held constant: G , T , and E Y i IS Lesson 64 9 For any given interest rate, expansionary fiscal policy (increase G , reduce T ) increases income… Y i IS
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Lesson_64_IS-LM - IS-LM An increase in income tends to...

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