Topic 6.pptx - CHAPTER 6 EQUILIBRIUM IN GOODS MONEY MARKET Combining IS-LM Curves \u2022 The IS curve is a set of real income-nominal interest rate

Topic 6.pptx - CHAPTER 6 EQUILIBRIUM IN GOODS MONEY MARKET...

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C HAPTER 6 EQUILIBRIUM IN GOODS & MONEY MARKET
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Combining IS-LM Curves
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IS–LM EQUILIBRIUM & DISEQUILIBRIUM LM Y r Y 0 r 0 r 2 A E IS LM IS A B C D E r Y 2 Y 0 Y 1 Y r 0 r 1
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Why point E is an equilibrium point?
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IS-LM ANALYSIS: A MATHEMATICAL APPROACH
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MONEY MARKET Money supply function: M s = M -------------------- (1) Money demand function: M d = c 0 + c 1 Y – c 2 r ------- (2) From (2): c 2 r = c 0 + c 1 Y – M d r = (c 0 + c 1 Y)/c 2 – (1/c 2 )M d (MD equation) When money market is in equilibrium state, M s = M d : M s = M d M = c 0 + c 1 Y – c 2 r c 2 r = c 0 + c 1 Y – M r = (c 0 /c 2 ) + (c 1 /c 2 )Y – (1/c 2 )M r = (c 0 /c 2 ) – (1/c 2 )M + (c 1 /c 2 )Y
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Numerical ExampleMoney supply: Ms= 100Money demand: Md= 40 + 0.1Y – 10rPrice level: P = RM2Income level: Y = 1,200(a)Calculate the equilibrium interest rate (r*) and quantity of money (M*).(b) Demonstrate your answer graphically.
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Answer:
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16 80 50 Md Ms 6 Interest rate (r) Qty of money (M) (b) Md = Ms
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GOOD MARKET In the IS-LM model, investment (I) is assumed to have an autonomous component and depends negatively on the interest rate (r) and can be written as: I = I 0 – ir (1)
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