IS-LM Flashcards
What is the National Account Identity?
Y = C + I + G + NX
What is Y?
Actual Production
What is Planned Expenditure?
E = C + I + G + NX
What two things are equal in equilibrium?
Y = E
What does it mean if E < Full Employment Production Yf?
Excess Supply
Deflationary Gap- Spare Capacity + Unemployment will rise
What does it mean if E > Full Employment Production Yf?
Excess Demand
Inflationary Gap
What does IS mean?
Investment - Saving curve
How is the IS curve derived?
Keynesian-cross model
Vary I.R + find associated level of Equilibrium Income
What does changing the I.R do?
Changes Planned Expenditure- C + I affected
How is the IS curve formed?
Adjust I.R –> Find associated level of E
- Shift E on Keynesian Cross Model
Find where E crosses 45º line + Join points on IS graph
What does LM mean?
Liquidity - Money curve
What time frame does the IS-LM model describe?
Very SR- Price Levels are Fixed
What does it mean for the LM curve if Price levels are fixed?
Cannot adjust to bring Equilibrium in Money Market
What happens in SR when M.S changes?
Prices do NOT change- I.R adjusts
What varies to make I.R adjust?
Income
e.g. Higher Income –> Higher M.D –> Increased I.R
Why is Money Demand Downward sloping?
Due to Liquidity Preferences
- Low I.R- people prefer to hold more Liquid Cash
- Anticipate Higher I.R/Returns in Future
What is the I.R in terms of Opportunity Cost?
Opportunity Cost of Holding Money
How is LM curve formed?
Change in Income (Y) –> M.D Shifts –> I.R adjusts
What does it mean at the Intersection of IS-LM?
Y = E & M.D = M.S
Equilibrium in Goods Market + Money Market
What happens if M.S Decreases?
LM Shifts LEFT –> Decreased Y + Increased I.R
How is AD curve derived from IS-LM model?
Increased Price Level –> Decreased Real M.S –> LM Shift LEFT –> Decreased Y + Increased I.R
- AD shows relationship between P + Y
- So, in space P,Y- IS_LM predicts NEGATIVE Relationship between P and Y–> AD Curve
