Lecture5_ISLM - EC3024 Managerial Macroeconomics Goods and Money Markets The IS-LM Model 5-1 The Goods Market and the IS Relation in the goods market

Lecture5_ISLM - EC3024 Managerial Macroeconomics Goods and...

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EC3024 Managerial Macroeconomics Goods and Money Markets: The IS-LM Model
5-1 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 . 2 EC3024- IS-LM Model Y C Y T I Y i G = - + + ( ) ( , ) 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 Relation Determining Output 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 3 EC3024- IS-LM Model
5-1 The Goods Market and the IS Relation Determining Output Note two characteristics of ZZ : § Because it’s not 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 45- degree line because it’s assumed that an increase in output leads to a less than one- for-one increase in demand. 4 EC3024- IS-LM Model
5-1 The Goods Market and the IS Relation Deriving the IS Curve (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 Curve Figure 5 - 2 5 EC3024- IS-LM Model
5-1 The Goods Market and the IS Relation Shifts of the IS Curve We have drawn the IS curve in Figure 5-2, taking as given the values of taxes, T , and government spending, G . Changes in either T or G will shift the IS curve. Changes in factors that decrease the demand for goods, given the interest rate, shift the IS curve to the left. Changes in factors that increase the demand for goods, given the interest rate, shift the IS curve to the right. 6 EC3024- IS-LM Model
5-1 The Goods Market and the IS Relation Shifts of the IS Curve An increase in taxes shifts the IS curve to the left.

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