chapter 4 Flashcards
what relationship does the level of production have with sales and how do you express it in chain of events?
An increase in the level of production implies an increase in the level of sales. As the level of production increases, the level of sales rises and firms tend to invest more – hence a positive relationship between the level of output and the level of investment.
In terms of a chain of events this is represented as:
Y↑ => I↑
Y↓ => I↓
Explain the relationship between investment and the interest rate. Explain with a chain of events and graphically
As the interest rate declines, planned investment spending in the economy increases.
Depicting the above by means of a chain of events gives us
i↓=> I↑ i↑ => I↓
how does the decrease in consumption spending affect income and what are the chain of events?
During this process there is also a decrease in consumption spending since consumption spending is a positive function of the level of output and income:
Y↓ => C↓
what is the LM curve?
The LM curve tells you all combinations of Y and r that equilibrate the money
market, given the economy’s nominal money supply M and price level P.
what is consumption according to the IS-LM model?
Consumption (C) is defined as C = C(Y-T) where T corresponds to government
taxes.
What are the 2 factors the depends on investment?
Investment (I) is not constant (no longer exogenous), and we see that it depends
mainly on two factors:
Level of output (+) and
Interest rate (-)
I = I(Y,i)
what is the IS curve?
The IS curve tells you all combinations of Y and r that equilibrate the output
market, given that firms are willing to supply any amount that’s demanded.
what does the IS curve derives from what relationship and what’s the formula?
The IS curve derives a relationship between interest rates and income in the short run.
Y = C (Y-T) + I (Y, i) + G
explain the equilibrium in the goods market of the IS-LM curve?
An Equilibrium in the goods
market implies that
* An increase in the interest rate
leads to a decrease in output.
- The IS curve is downward sloping.
1. IS Curve: The Investment = Savings curve
↑ i ⇒↓ I ⇒ Y ↓
explain what happens to the IS curve when taxes increase and what is the chain of events?
- An increase in taxes shifts the
IS curve to the left.
1. IS Curve: The Investment = Savings curve
↑ T ⇒↓ YD ⇒↓ C ⇒↓ Y
in the LM curve, explain the equilibrium?
In equilibrium, the real money supply is equal to the real money demand, which depends
on real income, (Y), and the interest rate (r)
what causes a movement along the LM curve?
When income decreases, money demand falls and as a result interest rates must decrease to restore money market equilibrium.
When income increases, money demand rises and as a result interest rates must increase to restore money market equilibrium.
what causes the LM curve to shift outwards?
An increase in the supply of money by the CB will result in an excess supply of money.
This will cause the LM curve to shift outwards in
order to restore equilibrium
what causes the LM curve to shift inwards?
An increase in the price level will raise money demand and result in an excess demand for money.
This will cause the LM curve to shift inwards to
restore equilibrium
explain the equilibrium on the goods market (IS curve)
Equilibrium in the goods market
implies that an increase in the
interest rate leads to a decrease in output.
