curve is ________ because the exchange
rate does not enter into the
LM
curve equation
o
Given the world interest rate, the
LM
*
equation
determines ______ _______, regardless of the
exchange rate
o
Diagram on the next page will make these
points clearer
1251
The
LM
Curve (
LM
*
)
o
Recall the equation for the
LM
curve
o
M
/
P
=
L
(
r
*
, Y
)
LM
*
o
The
LM
*
curve is
vertical
because the exchange
rate does not enter into the
LM
curve equation
o
Given the world interest rate, the
LM
*
equation
determines
aggregate income
, regardless of
the exchange rate
o
Diagram on the next page will make these
points clearer
1252
The
LM
*
Curve
LM
r
The _____ ____
equilibrium
condition
Determine the level
of ________
And the ______ _________
___
LM
*
Y
r = r
*
Y
e
1253
The
LM
*
Curve
LM
r
The
money
market
equilibrium
condition
Determine the level
of
income
And the
world interest
rate
LM
*
Y
r = r
*
Y
e
1254
Goods Market and Money Market Equilibrium
Occurs where:
o
_____*
o
and
o
_____
*
curves intersect
o
Note:
o
In a small open economy (SOE) the interest
rate is ____ and the exchange rate can ____
1255
Goods Market and Money Market Equilibrium
Occurs where:
o
IS
*
o
and
o
LM
*
curves intersect
o
Note:
o
In a small open economy (SOE) the interest
rate is
fixed
and the exchange rate can
vary
1256
Goods Market and Money Market Equilibrium
(The model on a
Y

e
graph)
IS
*
Y
e
Y
LM
*
1257
Goods Market and Money Market Equilibrium
(The model on a
Ye
graph)
e
Y
IS
*
Y
Equilibrium
Exchange
Rate
Equilibrium
Income
LM
*
1258
In Class Questions:
Question One
Why do we use the
*
notation in the equations for
the IS curve and
LM
curves respectively (i.e.
IS
*
and
LM
*
) in the Mundell Fleming model?
Question Two
What two conditions determine the level of income
along the
LM
*
curve?
1259
In Class Questions:
Question One
Why do we use the
*
notation in the equations for
the IS curve and
LM
curves respectively (i.e.
IS
*
and
LM
*
) in the Mundell Fleming model?
Answer  r = r
*
(See page 1242 in these notes)
Question Two
What two conditions determine the level of income
along the
LM
*
curve?
Money market equilibrium and world interest rate
(See page 1252 in these notes)
1260
The MundellFleming Model on a
Yr
Graph
o
So far we have seen the model on a ____ graph
o
Let’s briefly focus on the model on a ___ graph
o
After this brief discussion of the
Yr
graph, we
will
limit our analysis to a Ye graph only
1261
The MundellFleming Model on a Yr Graph
o
So far we have seen the model on a
Ye
graph
o
Let’s briefly focus on the model on a
Yr
Graph
o
After this brief discussion of the
Yr
graph, we
will
limit our analysis to a Ye graph only
1262
MundellFleming Model on a
Yr
Graph
o
In a small open economy the position of the
IS
curve depends on the ______ ________
o
The _______ _______ adjusts to ensure that the
IS
curve crosses the point where the
LM
curve intersects the horizontal line that
represents the world interest rate
r
*
o
See graph next page
o
1263
MundellFleming Model on a
Yr
Graph
o
In a small open economy the position of the
IS
curve depends on the
exchange rate
o
The
exchange rate
adjusts to ensure that the
IS
curve crosses the point where the
LM
curve
intersects the horizontal line that represents
the world interest rate
r
*
o
See Graph next page
1264
MundellFleming Model on a Yr Graph
12
12
In notes
r
Y
LM
IS (e)
r = r
*