12%20The%20IS-LM%20Model,%20Part%201

# 12%20The%20IS-LM%20Model,%20Part%201 - Agenda Equilibrium...

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1 12-1 The IS-LM Model, Part 1 12-2 Agenda • Equilibrium in the Labor Market: The FE Line. • Equilibrium in the Goods Market: The IS Curve. • What is Money? 12-3 Equilibrium in the Labor Market • Equilibrium in the labor market leads to employment at its full-employment level ( ) and output at its full-employment level ( ) . ¾ The full employment level of output is determined by the full-employment level of employment and the current levels of capital and productivity. N Y 12-4 The FE Line •Th e FE line is the combinations of output ( Y ) and the real interest rate ( r ) that establish equilibrium in the labor market. ¾ Because labor market equilibrium is unaffected by changes in the real interest rate, the FE

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2 12-5 The FE Line 12-6 The FE Line • Factors that shift the FE line: ¾ The full-employment line shifts right because of: • A beneficial supply shock, • An increase in labor supply, and/or • An increase in the capital stock. 12-7 An increase in A 12-8 Equilibrium in the Goods Market • The goods market is in equilibrium when desired investment, I d , equals desired national saving, S d . ¾ That is, when I d = S d . • If the goods market is not in equilibrium, then the real interest rate adjusts to bring about equilibrium.
12-9 The IS Curve •Th e IS curve is the combinations of output ( Y ) and the real interest rate ( r ) that establish equilibrium in the goods and services market. ¾ Or where I d = S d . 12-10 Deriving the IS Curve • To derived the IS curve: ¾ Start in the I d - S d diagram and find the level of output ( Y 0 ) and the real interest rate ( r 0 ) where I d = S d . ¾ Then change the level of output (to Y 1 ) and find the new real interest rate ( r 1 ) that re-establishes equilibrium so that I d = S d at Y 1 .

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12%20The%20IS-LM%20Model,%20Part%201 - Agenda Equilibrium...

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