IS-LM P2 Flashcards
Initially we assumed when looking at Keynesian cross that it was fixed but in reality know that it depends on interest rate
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Learn diagram deriving IS-LM curve?
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What does IS-LM stand for?
Investment-saving liquidity-money
How is r determined in the short run?
Theory of liquidity preference = a theory that suggests that the interest rate adjusts to bring the money supply and demand into balance
How does the ToLP assume interest rate adjusts?
Adjusts by the supply and demand of the most liquid asset in the economy tf money
The money supply (M) is determined by the CB. What is it’s important characteristic?
Not the nominal value of M, but the amount of G+S that can be bought with M
Draw supply of real money balances curve?
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Why is Supply of M vertical?
M is set by CB tf doesn’t depend on r
P is unaffected by r since in SR prices are sticky
Tf M/P doesn’t depend on r
Explain why the demand for real money balances has the shape it has?
- people prefer to hold cash since it can be used to buy G+S
- tf amount of cash depends on r since r is the opportunity cost of holding cash
- tf an increase in r raises the opportunity cost of holding money tf reducing the quantity of real money balances demanded
Draw demand and supply of real money balances diagram and show how it is used to derive the LM curve?
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Draw demand and supply of real money balances diagram and show how r is kept in equilibrium?
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What happens to keep r in balance if r>r(e)?
Increase deposits -> excess supply of funds tf decrease in r
What does the demand for real money balances depend on and why and function?
(M/P)^d = L(r,Y)
Interest rate as described before
Income since increase income -> increase consumption -> increase cash demanded
When does equilibrium in the money market occur?
When M/P (fixed) = L(r,Y)
What does the LM curve show?
That when income goes up, so does the real interest rate
Draw IS-LM diagram?
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For SR equilibrium in IS-LM, what two markets must be in eq?
Money market
G+S market
How would expansionary fiscal policy affect the IS-LM diagram and vice versa?
Expansionary FP -> increase in AE^P tf shifts IS curve right
Vice versa
Why does expansionary FP affect AE^P? (2)
Increase G means increase in G^P
Since C=C(Y-T) a fall in T means an increase in C^P
Why does a change in G cause an even greater change in Y?
Government purchaser multiplier
SEE DIAGRAM of AE^P shifting up
How does contractionary FP shift the IS curve?
Left
See page 7.
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How do changes in monetary policy affect the LM curve? Use a diagram to explain?
Fall Supply of M -> upward shift of LM curve
Increase Supply of M -> downward shift of LM curve
For a fixed income, the interest rate changes tf LM curve must shift
See crowding out effect diagram
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See page 11 (policy interactions)
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