Week 3 - IS-LM: goods market Flashcards
What happens to aggregate demand when interest rates increase?
If interest rates increases:
=> decrease in demand
=> curve shifts down
What happens to the IS curve when taxes increase increase?
Increase in demand:
=> left shift in IS
What part of the IS-LM relation affected by a change in fiscal policy?
How is expansionary fiscal policy achieved?
How is contractionary fiscal policy achieved?
Fiscal policy affects the goods market (IS curve)
Expansionary fiscal:
increase G-T
Contractionary fiscal:
Decrease G-T
What part of the IS-LM relation affected by a change in monetary policy?
How is expansionary fiscal policy achieved?
How is contractionary fiscal policy achieved?
Monetary policy affects the interest rate
(LM curve)
Expansionary monetary policy reduces the interest rate (drops LM)
contractionary monetary increases the interest rate (shifts up)
How can the government budget deficit be reduced without causing a recession?
If the government wants to reduce the budget
=> IS curve shifts left
Monetary policy then reduces the interest rate to avoid recession
How does a government deficit reduction effect Investment?
I = s + ( T - G )
given S, a higher T - G means a higher I
However, fiscal contraction lowers output and S reduces by more than T - G, so I decreases
In the short-run, how does a change in the interest rate affect unemployment, output and prices?
Unemployment increases
Output decreases
Prices change little
What two variable are investment dependant on in the extended IS-LM model?
dependant on level of output and interest rate (b_1Y & b_2i)
What do the different components represented in the investment equation of:
I = b_0 + b_1Y - b_2i
b_0:
autonomous investment
(independent of other factors)
b_1Y:
represents investment’s sensitivity to changes in output
b_2i:
investment’s sensitivity to changes in interest rate
