Chapter 9: The IS-LM Model: A General Framework for Macroeconomic Analysis Flashcards
What are the three main market of the economy?
labor market
goods market
asset market
What is mean by “full-employment level of employment”?
Equilibrium level of employment reached after wages and prices have fully adjusted.
What is meant by “full-employment output”?
Amount of output produced when employment level. for the current level of capital stock and the production function.
In what direction does the FE line shift, and for what reason, when there is an increase in…
labor supply
FE will shift to the right.
Equilibrium employment rises, raising full-employment output.
In what direction does the FE line shift, and for what reason, when there is an increase in…
the capital stock
FE will shift to the right.
More output can be produced with the same amount of labor. In addition, increased capital may increase the MPN, which increases labor demand and equilibrium employment.
Why does the savings curve slope up?
Because an increase in the real interest rate causes households to increase their desired level of savings.
Why does the investment curve slope downward?
Because an increase in the real interest rate increases the user cost of capital, which reduces the desired capital stock and hence desired investment.
For any level of output, the IS curve shows…
the real interest rate that clears the goods market.
Why does the IS curve slope downward?
Because a rise in output increases desired national saving, thereby reducing the real interest rate that clears the goods market.
An increase in the real interest rate results in a reduction of both…
Desired consumption, because people desire to save more when the real interest rate rises)
and
investment, because the use cost of capital increases when the real interest rate increases.
For constant output, any change in the economy that reduces national savings relative to desired investment will _____________ the real interest rate that clears the goods market and thus shift the ______________ curve _________.
increases
IS curve
Up and to the right
An increase in expected future output will shift the IS curve…
Why?
Shift:
Up and to the right.
Reason:
Desired savings falls (desired consumption rises), raising the real interest rate that clears the goods market.
An decrease in expected future output will shift the IS curve…
Why?
Shift:
Down and the the left.
Reason:
Desired savings will increase (desired consumption falls), lowering the real interest rate that clears the goods market.
An increase in gov. purchases will shift the IS curve…
Why?
Shift:
Up and to the right.
Reason:
Y < C + I + G
Desired savings fall (demand for goods rises), raising the real interest rate that clears the goods market.
A decrease in gov. purchases will shift the IS curve…
Why?
Shift:
Down and to the left.
Reason:
Y > C + I + G
Desired savings will rise (demand for goods falls), lowering the real interest rate that clears the goods market.
An increase in taxes will shift the IS curve…
Why?
Shift:
No change / down and to the left
Reason:
No change, if consumers take into account an offsetting future tax cut and do not change consumption (Ricardian Equivalence);
Down and to the left, if consumers don’t take into account a future tax cut and reduce desired consumption, increasing desired national savings and lowering the real interest rate that clears the goods market.
Y > C + I + G
An increase in the expected future marginal product of capital, MPKf, will shift the IS curve…
Why?
Shift:
Up and to the right
Reason:
Desired investment increases, raising the real interest rate that clears the goods market.
A decrease in the expected future marginal product of capital, MPKf, will shift the IS curve…
Why?
Shift:
Down and to the left
Reason:
Desired investment will fall, lowering the real interest rate that clears the goods market.
An increase in the effective tax rate on capital will shift the IS curve…
Why?
Shift:
Down and to the left
Reason:
Desired investment will fall, lowering the real interest rate that clears the goods market.
For a given level of output, any change that increases the aggregate demand for goods shifts the IS curve…
Y < C + I + G
Up and to the right, leading to higher real interest rates
In what direction must rates move in order to clear the goods market in the case of excess aggregate demand?
Real interest rates must rise in order to lower desired consumption and investment.
In what direction must rates move in order to clear the goods market in the case of excess aggregate supply?
Real interest rates must fall to increase desired consumption and investment.
Two categories of assets.
Name them.
- Monetary assets
2. Non-monetary assets.
What is the relationship between the price of a non-monetary asset and the interest rate on that asset?
When the price of a non-monetary asset increases, the yield on that asset decreases.
When the price of a non-monetary asset decreases, the yield on that asset increases.