IS-LE Framework

Question 1

What are the expected factors for economic growth?

Answer 1

1. Expected future income increases.
2. Government spending increases.
3. Future MPK increases.
4. Price of capital goods decreases.

Question 2

What is the LM Curve?

Answer 2

The LM curve represents the relationship between the real interest rate (r) and output (Y)(GDP) in the money market, where the supply of money equals the demand for money.

How Interest Rates Work in the Money Market:
•	If the economy gets bigger (Y goes up), people need more money to buy things.
•	But the total amount of money in the system doesn’t automatically change, so the interest rate goes up to balance everything (it becomes more “expensive” to borrow money).
3.	The Curve:
•	The LM curve slopes upward because, as the economy grows (higher Y), interest rates (r) also rise to keep the money market in balance.

Question 3

What is the LM Curve equation?

Answer 3

Formula: M/P = L(Y).

Real money supply M/P = Real money demand L.

Question 4

What factors shift the LM Curve?

Answer 4

The LM curve shifts when the real money supply (M/P) changes due to central bank actions - ppl hv more liquidity more real money in economy - interest rate must fall to restore equilibrium with supply and demand of money

or price level changes, or when money demand changes due to financial innovations or shifts in preferences.

Question 5

What is the FE Line?

Answer 5

FE Line: Shows output level at which the labor market is in equilibrium.

The FE Line is about the labor market, or where people work and businesses hire. It shows the maximum amount the economy can produce when everyone who wants a job has one (this is called full employment).

• Right:
• More workers available (e.g., population grows).
• Better technology makes workers more productive.
• More tools and equipment (capital).
• Left:
• A disaster destroys factories or equipment.
• Fewer workers (e.g., aging population).

Question 6

What factors shift the FE Line?

Answer 6

Shifts if:
1. Productivity (z) changes.
2. Capital stock K changes.
3. Labor supply changes.

Question 7

What is General Equilibrium?

Answer 7

General Equilibrium: Occurs when IS, LM, and FE intersect.

Question 8

What are the key variables in IS-LM-FE?

Answer 8

Y: Output, r: Real interest rate, P: Price level.

Question 9

IS Curve Definition

Answer 9

IS Curve: Shows combinations of real interest rater and output Y where the goods market is in equilibrium.

If the interest rate goes up, borrowing becomes expensive, and businesses don’t invest as much.
• If the interest rate goes down, borrowing becomes cheap, and businesses invest more, which increases the total output of the economy.

Question 10

What shifts IS

Answer 10

Components of Aggregate demand

C + I + G + NX