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# If investment does not depend on the interest rate

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Unformatted text preview: hat arises from equilibrium in the market for goods and services. That is, Answer: it describes the combinations of income and the interest rate that satisfy the equation a. The IS curve represents the relationship between the interest rate and the level of income that Y C goods + I services. arises from equilibrium in the market=for(Y – T) and(r) + G. That is, it describes the combinations of income and the interest rate that satisfy the equation Answers to Textbook Questions and Problems Y = C (Y – T ) + I(r) + G . If investment does not depend on the interest rate, then nothing in the IS equa- tion depends on If investment does not depend to ensure that the quantity n goods in the IS equathe interest rate; income must adjuston the interest rate, then ofothing produced, Y, equals the tion depends on the interest+rate;G. Thus, must adjustis vertical at this the quantity in quantity of goods demanded, C I + income the IS curve to ensure that level, as shown of goods produced, Y, equals the quantity of goods demanded, C + I + G. Thus, the Figure 11–16. IS curve is vertical at this level, as shown in Figure 11–16. r Figure 11–16 IS Interest rate LM Y Income, output b. Y Monetary policy has no effectno effect on output, because the IS curve Y. Monetary Y. Monetary policy has on output, because the IS curve determines determines policy can affect only the interest rate. In contrast, fiscal policy is In contrast, fiscal policy is effec-full Monetary policy can affect only the interest rate. effective: output increases by the amountoutput increases shifts. full amount that the IS curve shifts. tive: that the IS curve by the The LM curve represents the combinations of income and the interest rate at b. whichM curve represents the combinations of income and the interest rate atdepend the money The L the money market is in equilibrium. If money demand does not which on the interest rate, then we can demand LM not depend market is in equilibrium. If moneywrite thedoes equation ason the interest rate, then we can write the LM equation as M/P = L(Y). For any M/P = L(Y).given level of real balances M/P, there is only one level of income at which the money market is in equilibrium. Thus, the LM curve is vertical, as shown in Figure 11–17. For any given level of real balances M/P, there is only one level of income at which the money market is in equilibrium. Thus, the LM curve is vertical, as shown in Figure 11–17. Figure 11–17 r LM Interest rate 108 IS Y Income, output c. Y Fiscal policy now has no effect on output; it can affect only the interest rate. Monetary policy is effective: a shift in the LM curve increases output by the full amount of the shift. If money demand does not depend on income, then we can write the LM equation as M/P = L(r). the interest rate, then we can write the LM equation as M/P = L(Y). For any given level of real balances M/P, there is only one level of income at which the money market is in equilibrium. Thus, the LM curve is vertical, as shown in Figure 11–17. Figure 11–17 r Interest rate LM IS Y Y Income, output Fiscal policy no effect on effect on output; it can the interest rate. Monetary policy is Fiscal policy now has now has no output; it can affect only affect only the interest rate. Monetary policy is effective: a shift in the LM curve amount of the shift. effective: a shift in the LM curve increases output by the fullincreases output by the full amount of the shift. c. c. If money demand does not depend on on income, r 1 1 we can writeLM eLII equation If money demand does not depend income,pthen we can write the the quation 109 as C h a t e then Aggregate Demand M as M/P = L(r). M/P = L(r). F any given level of of balances M/P there there one level of level of the interest Foror any given levelreal real balances, M/P, is only is only one the interest rate at which the mrate at which the money market is the equilibrium. horizontal, asLM curve Figure 11–18. oney market is in equilibrium. Hence, in LM curve is Hence, the shown in is horizontal, as shown in Figure 11–18. Figure 11–18 Interest rate r LM1 LM2 IS Y Income, output Fiscal policy is very effective: output increases by the full amount curve shifts. Fiscal policy is very effective: output increases by the full amount that the IS that the IS curve shifts. Monetary policy an increase in the money supplyin the money supply to fall, Monetary policy is also effective: is also e...
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