Chapter 11 BookShocks to the IS curve are exogenous changes in the demand for goods and services. Shocks to the IS curve may also arise form changes in the demand for consumer goods. (firms become pessimistic about the future of the economy causing them to build fewer factories. This reduction in the demand for investment goods causes a contractionary shift in the investment function, shifting the IS curve to the left)Shocks to the LM curve arise from exogenous changes in the demand for money (ex. New restrictions on credit-card availability increase the amount of money people choose to hold. Increasing money demand and shifting the LM curve upward, increasing interest rate and depressing income.)Federal funds rate- short term policy instrument. Fed sets this rate. for instance if reported fed has lowered interest rate it really means the federal open market committee has instructed the fed bond traders to buy bonds in open-market ops so as to increase the money supply, shift the LM curve, and reduce the eq. interest rate to hit a new lower target.Shcoks to the LM curve are more prevalent than shcoks to the IS curve. Therefore when the fedtargets interest rates, it automatically offses LM shocks by adjusting the money supply, (exacerbating IS schocks though). B/c LM are more prevalent this leads to greater economic stabilityWHAT IF PRICE LEVEL IS ALLOWED TO CHANGEIn IS-LM higher price reduces M/P moving LM curve upwards, reducing Y and increasing r.A change in income in the IS-LM model resulting from a change in the price level represents a movement along the aggregate demand curve. A change in income in the IS-LM model for a given price level represent a shift in the aggregate demand curve.Keynesian approach complete the model with the assumption of fixed price adding to the IS andLM equations P=P1- best describes short runThe classical approach completes the model with the assumption that output reaches its naturallevel so Y=Y (bar)- best describes the long runa. An increase in government purchases financed by borrowing.