Book: The IS-LM Model

Question 1

What is the IS relation

Answer 1

The condition in the goods market that production equals demand

Y=Z

Question 2

What factors influence investment

Answer 2

The level of sales and interest rate

Question 3

What does this function mean
I = I(Y,i)
(+,-)

Answer 3

that investment is a function of sales output that has a positive affect as investments may be needed to meet demand and interest rate that has a negative output as companies that needs to loan to invest might be reluctant if the interest rate is high

Question 4

What does it mean that the IS curve slopes downward

Answer 4

That as interest rises output decreases as investment and demand decreases

Question 5

How does a factor like taxes, decreased government spending or consumer confidence that decreases the level of demand at the current interest rate affect the IS curve

Answer 5

It moves it to the left, if taxes decrease or confidence and public spending increases the IS curve would move to the right

Question 6

What foes this mean
M/P = Y*L(i)

Answer 6

It is accomplished by dividing the money supply equilibrium M=$Y*L(i) by P as in price. That real money supply, money in terms of goods, is equal to real income times a function determined by interest which leans downwards.

Question 7

What is the LM relation

Answer 7

M/P = Y*L(i)
Real money supply is equal to real production times the effect of the interest rate

Question 8

Dies the central bank choose the interest rate or the money supply

Answer 8

They choose the interest rate by controlling the money supply so they say they choose interest rate but in reality they control one with the other

Question 9

What is the LM curve

Answer 9

LM is not a curve but simply a line representing the interest rate chosen by the central bank regardless of output

Question 10

How does the IS and LM curves interact

Answer 10

Where they cross determines output, where both financial markets and the goods market is in equalibrium

Y = C(Y-T)+I(Y,i) + G
i is decided by LM

Question 11

What is a fiscal contraction or cinsolidation

Answer 11

When G-T decreases by increasing taxation or decreasing government spending

Question 12

What is a fiscal expansion

Answer 12

An increase in G-T by either reducing taxes or increasing the government budget

Question 13

What is a monetary expansion

Answer 13

A decrease in interest rate

Question 14

What is an increaese in interest rate called in monetary policy

Answer 14

Monetary contraction or monetary tightening

Question 15

What is the difference between monetary policy and fiscal policy

Answer 15

Monetary is done by the central bank and fiscal policy is done by the government. Fiscal policy shifts IS while monetary shifts LM

Question 16

What is the policy mix

Answer 16

To use fiscal and monetary policy together

Question 17

Why is it bad to go too far with ether fiscal or monetary policy

Answer 17

decreasing taxes will lead to less means and increased spending without the taxes might necessitate increased debt. The central bank is limited by the zero lower bound

Question 18

What can the government do if it wants to reduce its debt without triggering a recession

Answer 18

They can do monetary expansion to of-set the fiscal contraction

Question 19

What is fiscal austerity

Answer 19

To reduce government debt and decreasing interest to not trigger a recession

Question 20

How long foes it take for monetary policy to have an effect

Answer 20

The time lag is long, 2 years for full effect

Question 21

Why does the IS-LM model not work in the medium run

Answer 21

Because prices are not constant