Chapter 8 Flashcards
what does the size of the multiplier effect depend on?
marginal propensity to consume - the proportion of income spent on goods and services
what does IS curve show? why does it slope downward?
how IR affects the production level
downward as an increase in IR has a negative impact on Consumption and Y
what does the effects of interest rate on demand depend on? what does a change imply?
- interest sensitivity of investment and consumption
- size of the multiplier
Implies movement ALONG the IS curve
what shifts the IS curve and why?
changes in exogenous variables which directly effect consumption and investment eg. increased consumer optimism
what does increased consumer optimism do to the IS curve when the money supply is constant?
shifts IS to the right (up)
leading to a new equilibrium with higher production and interest rate for a constant money supply
higher AD leads to higher Y transactions increase
leading to an increase in money demand
people less willing to lend which increases iR counteracting the increase in production
what is the IS-LM model? what does it show?
theory of economic activity in the SR
price level is taken as given
production determined by AD
it shows the good and money markets together to determine level of production and interest rates
what is the goods market and money market equilbriums?
goods market equilibrium
Y = AD
Y = C(Y.Ye, i - expected inflation, A) + I (i- expected inflation, Ye, K)
moeny market equilibrium
money supply = money demand
M/P = Y/V(i)
what is production determined by?
determined by aggregate demand
Y = C + I
what is the multiplier effect? why is it bigger than unity?
implies any exogenous change in demand will raise production more than the intial increase in demand
an increase in demand increases production and income leads to a further increase in consumption and investment
what does LM curve show? Why does it slope upwards?
what the IR will be in the money market for each level of production for a given money supply
what can shift the LM curve? what does an expansion of the money supply do?
higher production leads to increase IRs as production increases transactions increase
IR must rise to keep money demand = money supply
increase in money supply or decrease in price level shifts LM downward
LM shifts down leading to a new equilibrium with reduce IR but higher Prices
what does the central bank have to do to hold the interest rate constant when there is an increase in demand?
CB has to increase the money supply so that the LM and IS curve shift together
increase in production will be larger
why is it unlikely money supply or interest rates will remain constant?
CB will react in way it finds appropriate
what does empirical evidence from the statistical VAR model suggest about an increase in IR?
has a negative effect on production and employment with max effect occuring after 6 quarters
inflation falls but only after a considerable lag and the maximum effect on inflation occurs after about 2 years
