is- lm model, Ejercicios de Macroeconomía

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GOODS AND FINANCIAL MARKETS: IS-LM MODEL

SHORT RUN IN A CLOSED ECONOMIC SYSTEM

THE GOOD MARKETS AND IS CURVE

 The Good markets assumption:

 The production Y is equal to the demand for goods Z;  The demand is the sum of consumption, investments and government spending. Z=C(Y-T)+I+G;  The equilibrium condition is given by Y=Z such that Y=C(Y- T)+I+G.

NEW OUTPUT FORMULA

DERIVING THE IS CURVE

Y

Y ; Z

A

Z < Y

Z > Y

ZZ

ZZ’

For i’>i

DERIVING THE IS CURVE 2

Y

S

S

I

I

i i Y

IS

SHIFTS OF THE IS CURVE

Y

i

A

Y’ Y

i

IS (for a given T)

IS (for T’> T)

Government intervention on Taxation and Government spending shifts the IS curve for each interest rate and output. level

DERIVING THE LM CURVE

i M

𝑑 M

𝑠 i

A

A’

i’ 𝑀 𝑑′ An increase in output level leads an increase in the demand for transaction money, it implies a shift of the liquidity demand on the right hand side. So people want to hold money and the increase of the interest rate that leads to want to hold less money.

DERIVING LM CURVE 1

i M

𝑑 M

𝑠 i

A

A’

i’ 𝑀 𝑑′ i Y Y i

A

A’

i’ Y’

IS-LM EQUILIBRIUM

 IS equilibrium: the supply of goods is equal to the demand for goods.  LM equilibrium: the supply of real money is equal to the demand for money 𝐼𝑆: 𝑌 = 𝐶 𝑌 − 𝑇 + 𝐼 𝑌, 𝑖 + 𝐺 𝐿𝑀:

IS-LM MODEL

IS curve: any point on the downward-sloping curve corresponds to equilibrium in goods markets; LM curve: any point on the upward-sloping curve corresponds to equilibrium in financial markets: Point A.: this point corresponds to equilibrium conditions satisfied i Y Y i

A

IS LM

THE FISCAL EXPANSION

i Y Y i

A

IS IS’ LM

Crowding out of investments 1 ° the taxes 'reduction leads an increase in disposable income and, as consequence, an increase in consumption; 2 ° we assist to an increase both the aggregate demand and, for the IS assumption, general output. 3 ° Consequently the IS curve shifts to the right, from IS to IS’. 4 ° the fiscal expansion doesn’t affect the LM equilibrium so the curve doesn’t shift. 5 ° the economy moves along the LM curve, in fact the interest rates runs up to maintain the same level of the real supply of money i’

EXPANSIONARY MONETARY POLICY

i Y Y i

A

IS LM

LM’

1 st^ CB decides to implement the supply of money in the economy. What happens? (remind to expansionary open markets operations). Why do the interest rate decrease? 2 nd^ The interest rate’s decrease leads to an increase of the demand for transactions, an increase in investments and, in turn, o in demand and output. 3 rd the economy moves along the IS curve;

THE MONETARY POLICY MULTIPLIER

 Considere the LM curve equation: 𝑀 𝑃

 The linear equation is : 𝑀 𝑃

 The LM equilibrium equation 𝑌 =

THE IS-LM EQUILIBRIUM IN FORMULA

IS: 𝑌 = 1 1 −𝑐 1 −𝑑 1 𝐴 − 𝑑 2 1 −𝑐 1 −𝑑 1 𝑖 LM: 𝑌 = 1 𝑓 1 𝑀 𝑃

𝑓 2 𝑓 1 𝑖

The equations show us that both variables Y and i are in function of exogenous variables: the money supply and the Autonomous spending. An increase of A leads an increase in Output and in interest rate. An increase of M/P leads an increase in Y but a decrease of interest rate The Monetary Policy Multiplier The Fiscal Policy Multiplier