EC21A-Lecture_5_2009 - Intermediate Macroeconomics I...

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Unformatted text preview: Intermediate Macroeconomics I EC21A (Econ 2002) IS-LM Model The LM Curve Recall: The IS curve gives a relationship between income and interest rate under given conditions. The IS curve by itself cannot determine output and interest rate. We need another curve that gives another relationship between income and interest rate. The LM Curve Introduction The LM curve summarizes the positive relationship that exists between the interest rate and income when there is equilibrium in the money market. Y 2 Y 1 R Y R 2 R 1 LM The LM Curve Shows all the combination of Y & R for which the demand for money is equal to the supply Keynesian cross is the building block for the IS curve Theory of Liquidity Preference is the building block for the LM curve Liquidity Preference Theory Shows how the demand and supply of money determines the interest rate Liquidity Preference Theory Money Demand is the money demand function. Money Demand refers to the quantity of money (M1) that households want to hold. The demand for real money balances is a function of both income and interest rate. hR kY P M- = Liquidity Preference Theory Money Demand Money Demand is Positively related to income » If the income increases then consumption will increase » To facilitate this increase consumption households must hold more money....
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This note was uploaded on 12/15/2011 for the course ECON EC21A taught by Professor Georgiamcleod during the Fall '09 term at University of the West Indies at Mona.

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EC21A-Lecture_5_2009 - Intermediate Macroeconomics I...

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