# Lecture 5 - LECTURE5 THEGOODSAND FINANCIALMARKETS:IS...

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LECTURE 5 THE GOODS AND  FINANCIAL MARKETS: IS- LM MODEL 1 of 35

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The Goods Market and the  IS  Relation Equilibrium in the goods market exists when production, Y , is equal to the demand for goods, Z . This condition is called the IS relation. In the simple model developed in chapter 3, the interest rate did not affect the demand for goods. The equilibrium condition was given by: 2 of 35 Y C Y T I G = - + + ( ) 5-1
Investment, Sales, and the Interest Rate In this chapter, we capture the effects of two factors affecting investment: The level of sales (+) The interest rate (-) ( , ) + - 3 of 35 I I Y i = ( , )

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Determining Output Taking into account the investment relation above, the equilibrium condition in the goods market becomes: ( , ) + - 4 of 35 I I Y i = ( , ) Y C Y T I Y i G = - + + ( ) ( , )
Determining Output 5 of 35 For a given value of the interest rate i, demand is an increasing function of output, for two reasons: An increase in output leads to an increase in income and also to an increase in disposable income therefore increase consumption. An increase in output also leads to an increase in investment.

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The Determination of Output 6 of 35 The demand for goods is an increasing function of output. Equilibrium requires that the demand for goods be equal to output. Equilibrium in the Goods Market Figure 5 - 1
The Determination of Output 7 of 35 Note two characteristics of ZZ: Because it’s assumed that the consumption and investment relations in Equation (5.2) are linear, ZZ is, in general, a curve rather than a line. ZZ is drawn flatter than a

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## This note was uploaded on 01/05/2012 for the course ECON 202 taught by Professor Tunc during the Spring '10 term at Middle East Technical University.

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Lecture 5 - LECTURE5 THEGOODSAND FINANCIALMARKETS:IS...

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