Lecture 18 IS Curve and Stabilization Policy

Question 1

when is investment I high?

Answer 1

when interest rates are low

Question 2

when is consumption C high?

Answer 2

when interest rates are low

Question 3

when are savings S high?

Answer 3

when output Y is high

Question 4

IS (investment-savings) curve relationship

Answer 4

negative relationship between output and interest rates
low interest rates lead to high demand (consumption and investment) leads to high output

Question 5

output gap

Answer 5

the % difference between actual output Yt and “potential output” Ytp (what would have happened in the absence of shocks)
determines unemployment rate u (okun’s law)

Question 6

output gap formula

Answer 6

yt = (Yt - YtP)/YtP

Question 7

IS curve formula

Answer 7

yt = dt - β(rt-r)
yt = output gap
dt = shock to aggregate demand (in normal times d = 0)
β > 0 = sensitivity of aggregate demand with respect to r
rt = the real interest rate
r = the natural rate of interest: 2%

Question 8

low interest rates in IS curve

Answer 8

positive output gaps - the economy produces more than its potential

Question 9

high interest rates in IS curve

Answer 9

cause negative output gaps - the economy produces less than its potential