1Y AE Approach In equilibrium state Y C I G A Therefore equation A can be

1y ae approach in equilibrium state y c i g a

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(1)Y = AE Approach In equilibrium state: Y = C + I + G -------- (A) Therefore, equation A can be rewritten as: Y = a + bY d + I 0 – ir + G Y = a + b(Y – T) + I 0 – ir + G Y = a + bY – bT + I 0 – ir + G Y – bY = a – bT + I 0 – ir + G (1 – b)Y = I 0 – ir + G + a – bT Y IS = 1/(1 – b) [ I 0 + G + a – bT] – ir/(1 – b) (IS Equation)
(2) Injection-Leakage Approach In equilibrium state: I + G = S + T -------- (B) Therefore, equation B can be rewritten as: I 0 – ir + G = –a + (1 – b)Y d + T I 0 – ir + G = –a + (1 – b)(Y – T) + T I 0 – ir + G = –a + Y – bY – T + bT + T I 0 – ir + G = –a + Y – bY + bT I 0 – ir + G = –a + (1 – b)Y + bT I 0 – ir + G + a – bT = (1 – b)Y (1 – b)Y = I 0 – ir + G + a – bT Y IS = 1/(1 – b) [ I 0 + G + a – bT] – ir/(1 – b) (IS Equation)
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Numerical Example 1C = 60 + 0.8YdI = 150 – 10rG = 250T = 200Ms= 100Md= 40 + 0.1Y – 10r (a) Derive equations for the IS and LM curve.(b)Compute the equilibrium values for income (Y*) and the interest rate (r*).(c) Show your answers in (a) and (b) graphically.
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Numerical Example 2C = 130 + 0.5YdI = 200 – 600rG = 112T = 20 + 0.2YMs/P = 300Md/P = 50 + 0.5Y – 600r(a) Derive equations for the IS and LM curve.(b)Compute the equilibrium values for income (Y*) and the interest rate (r*).(c) Show your answers in (a) and (b) graphically.(d)Suppose that G increases to 200. Compute the new equilibrium values of Y* and r*.(e) Show your answers in (b) and (d) in an appropriate diagram.
Policy Effects in the IS-LM Model There are two types of policies: (a) Monetary Policy – Changing the MS. i. Expansionary MP: MS ii. Contractionary MP: MS (b) Fiscal Policy – Changing G or T. i. Expansionary FP: G and/or T ii. Contractionary FP: G and/or T
Monetary Policy in the IS-LM Framework Monetary policy transmission mechanism Change in nominal money stock Change in nominal interest rate Change in investment spending Change in equilibrium income
Monetary Policy in the IS-LM Framework (a) The Effect of an Increase in the Nominal Money Stock LM 0 Y r Y 1 r 3 r 1 E’ E M D (y 0 ) M S1 /P 0 M S0 /P 0 m M 0 /P 0 r 2 r 1 r E E’ M 1 /P 0 LM 1 Suppose that MS while P unchanged. MS LM curve shifts downward, r , Y . F r 2 Y 2 r 3 F M D (y 2 ) IS

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