14.02_lecture_11-12

14.02_lecture_11-12 - IS IS-LM Roadmap 1) MARKET I : GOODS...

Info iconThis preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon
M IS IS-LM LM
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Roadmap 1) MARKET I : GOODS MARKET goods demand = C + I + G (+NX) = Y = goods supply (set by maximizing firms) IS curve 2) MARKET II : MONEY MARKET money demand = L d (Y, r + π e ) = M s /P = money supply (set by the Fed) M curve LM curve - M QUILIBRIUM = EQUILIBRIUM IN BOTH MARKETS I and II 2 IS LM EQUILIBRIUM EQUILIBRIUM IN BOTH MARKETS I and II
Background image of page 2
Goods Market IS curve represents the equilibrium in the goods market: ) =C+I+G+NX (1) Y = C + I + G + NX Recall the definition of private savings S (hh) = Y – T – C Recall the definition of national savings S = S (hh) + T – G Combining them (2) S±= ±Y±–C ±–G± From (1) and (2) the demand side of the economy can be written as: S = I + NX 3 The IS curve is named as it is because it documents the relationship between Investment and Saving (holding NX constant).
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Demand side : the IS curve C is a function of PVLR (Y, Y f , W), tax policy, expectations, etc. I is a function of r, A f , K, and investment tax policy. G is a function of government policy (we will discuss this shortly) NX we will model in the last lecture of the course (for the U.S., NX is small) The IS curve relates Y to r . How do interest rates affect Y? As r falls, Investment increases (due to firm profit maximization behavior). Also Consumption increases (substitution effect dominates) 4 IS curve is downward sloping in {r, Y} space .
Background image of page 4
IS Curve: Graphical Derivation I curve S curve (Y=Y 1 ) r r r* r* I,S Y Y 1 5
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
IS Curve: Graphical Derivation I curve S curve (Y=Y 1 ) r IS r S curve (Y=Y 2 ) r 1 r 2 I,S Y n increase in current Y leads to more desired S Y 1 Y 2 6 An increase in current Y leads to more desired S, hence the equilibrium r needs to be lower!
Background image of page 6
IS curve r r* r* Y IS Y Suppose r is set by the Fed at the level of r* (we will explore this in depth later in the course). For a given r, we can solve for the level of output desired by the demand side of the economy. e represent the demand side of the economy drawn in {r Y} space as the I curve Why IS? 7 We represent the demand side of the economy, drawn in {r,Y} space as the I-S curve. Why IS? Because the demand side of the economy can be boiled down to I = S (when NX is zero)
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
What shifts the IS curve What shifts the IS curve to the right? Anything that increases C, I or G (or NX when we model it): higher expected income or wealth higher PVLR higher C higher conusmer confidence higher PVLR higher C higher Tr or lower T (if the Ricardian equivalence fails) higher C igher expectations about f igher PK f igher higher expectations about A higher MPK higher I higher business confidence higher MPK f higher I lower δ or mm, or lower t K lower adjusted user cost of K higher I higher G Changes in r WILL NOT cause IS curve to shift 8 (causes movement along IS curve)
Background image of page 8
Image of page 9
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 10/25/2009 for the course 14 14.02 taught by Professor Geurrieri during the Fall '09 term at MIT.

Page1 / 39

14.02_lecture_11-12 - IS IS-LM Roadmap 1) MARKET I : GOODS...

This preview shows document pages 1 - 9. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online