EC3024Managerial MacroeconomicsGoods and Money Markets: The IS-LM Model
5-1 The Goods Market and the ISRelationEquilibrium in the goods market exists when production, Y, is equal to the demand for goods, Z. This condition is called the IS relation.2EC3024- IS-LM ModelYCYTIYiG=-++()(,)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.§An increase in output also leads to an increase in investment.
5-1 The Goods Market and the IS RelationDetermining OutputThe demand for goods is an increasing function of output. Equilibrium requires that the demand for goods be equal to output.Equilibrium in the Goods MarketFigure 5 - 13EC3024- IS-LM Model
5-1 The Goods Market and the IS RelationDetermining OutputNote two characteristics of ZZ:§Because it’s not assumed that the consumption and investment relations in Equation (5.2) are linear, ZZis, in general, a curve rather than a line.§ZZ is drawn flatter than a 45-degree line because it’s assumed that an increase in output leads to a less than one-for-one increase in demand.4EC3024- IS-LM Model
5-1 The Goods Market and the IS RelationDeriving the ISCurve(a)An increase in the interest rate decreases the demand for goods at any level of output, leading to a decrease in the equilibrium level of output. (b)Equilibrium in the goods market implies that an increase in the interest rate leads to a decrease in output. The IS curve is therefore downward sloping. The Derivation of the IS CurveFigure 5 - 25EC3024- IS-LM Model
5-1 The Goods Market and the IS RelationShifts of the ISCurveWe have drawn the IS curve in Figure 5-2, taking as given the values of taxes, T, and government spending, G. Changes in either Tor Gwill shift the IScurve.•Changes in factors that decrease the demand for goods, given the interest rate, shift the IScurve to the left. •Changes in factors that increase the demand for goods, given the interest rate, shift the IScurve to the right.6EC3024- IS-LM Model
5-1 The Goods Market and the IS RelationShifts of the ISCurveAn increase in taxes shifts the IScurve to the left.