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IS-LM MODEL

IS-LM MODEL. Miscellaneous. Simple Keynesian Model v.s. IS-LM Model G ’ (b = 0). C, I, G, G’ , AD. r. Slope = s/b =  b = I/r = 0. IS 1. IS 2. LM. Y. Y. ( C’-cT’+I’+G’)/s. ( C’-cT’+I’+G’)/s. Simple Keynesian Model v.s. IS-LM Model G ’ (b = 0). Simple Keynesian Model

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IS-LM MODEL

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  1. IS-LM MODEL Miscellaneous

  2. Simple Keynesian Model v.s.IS-LM Model G’ (b = 0) C, I, G, G’, AD r Slope = s/b =  b = I/r = 0 IS1 IS2 LM Y Y (C’-cT’+I’+G’)/s (C’-cT’+I’+G’)/s

  3. Simple Keynesian Model v.s.IS-LM Model G’ (b = 0) • Simple Keynesian Model • Ye = kE G’ = G’/s • IS-LM Model • Ye = kE G’ = G’/s • interest rate has increased but investment would not decrease since b=0, i.e., investment is perfectly interest inelastic • No crowding-out effect

  4. Simple Keynesian Model v.s.IS-LM Model G’ (b  0) C, I, G, G’, I’,AD r Slope = s/b IS1 IS2 LM Y Y (C’-cT’+I’+G’)/s (C’-cT’+I’+G’)/s

  5. Simple Keynesian Model v.s.IS-LM Model G’ (b  0) • Simple Keynesian Model • Ye  kE G’  G’/s • IS-LM Model • Shift of the IS curve: Y = kE G’ = G’/s • Ye  kE G’  G’/s • interest rate has increased and investment would decrease since b  0, • the IS-LM multiplier = Ye/G’ = • crowding-out effect 1 s+b (d/e)

  6. Simple Keynesian Model v.s.IS-LM Model G’ (e = ) C, I, G, G’, AD r Slope = d/e = 0 e = Ma/r =  Liquidity Trap d = Mt/Y = 0 IS1 IS2 LM Y Y (C’-cT’+I’+G’)/s (C’-cT’+I’+G’)/s

  7. Simple Keynesian Model v.s.IS-LM Model G’ (e =  ) • Simple Keynesian Model • Ye = kE G’ = G’/s • IS-LM Model • Ye = kE G’ = G’/s • Mt has increased when Y, normally, interest rate has to increase to induce people to hold less Ma, as r would raise the return from holding bond • However, when there’s a liquidity trap, people’s demand for money as an asset, which provides liquidity, is unlimited (e = Ma/r = ) , they would hold as much Ma as possible, r would remain constant, thus no crowding-out effect.

  8. Simple Keynesian Model v.s.IS-LM Model G’ (d = 0 ) • The diagram is the same as slide no.6 • Simple Keynesian Model • Ye = kE G’ = G’/s • IS-LM Model • Ye = kE G’ = G’/s • When there’s an increase in government expenditure, income increase by kE G’ , but transaction demand for money would not increase (d = Mt/Y = 0), Ma need not decrease and r need not increase. With the same interest rate, there’s no crowding-out effect.

  9. Simple Keynesian Model v.s.IS-LM Model G’ (Vertical LM) C, I, G, G’, I’,AD r IS1 IS2 LM Slope = d/e =  d=Mt/Y= e=Ma/r=0 Y Y (C’-cT’+I’+G’)/s (C’-cT’+I’+G’)/s

  10. Simple Keynesian Model v.s.IS-LM Model G’ (Vertical LM) • Simple Keynesian Model • Ye = 0 • IS-LM Model • Ye = 0 • Full Crowding Out Effect • When d=Mt/Y=, G’ Y by kEG’ Mt by  so Y has to reduce to the original level • When e=Ma/r=0, G’ Y by kEG’ Mt but Ma would not decrease, so Mt has to reduce to the original level to restore equilibrium in the money market

  11. Simple Keynesian Model v.s.IS-LM Model G’=T’ (b = 0)Balanced-Budget Change C, I, G, G’, T’, AD r Slope = s/b =  b = I/r = 0 LM IS1 IS3 IS2 Y Y (C’-cT’+I’+G’)/s (C’-cT’+I’+G’)/s

  12. Simple Keynesian Model v.s.IS-LM Model • Simple Keynesian Model • Cannot be used to analyze monetary policy • IS-LM Model • Can be used to analyze monetary policy

  13. Demand Curve Slope of tangent = P/Qd = 0 Ed = (Qd/Qd)/(P/P) =  It measures the responsiveness of Qd of a good to a change in the price of the good Ed = slope of ray / slope of tangent P Qd

  14. Deriving the IS FunctionTwo-Sector Injection = WithdrawalI = S r I= I’ - br y-intercept =I’/b x-intercept = I’ slope =1/b b = I/r IS y-intercept = I’/b x-intercept = I’/s slope = s/b * Y I * C’ = 0 = S’ S = sY slope = s s =S/Y J = W I = S S

  15. Deriving the IS FunctionFour-Sector Injection = WithdrawalI + G + X = S + T + M r J = G’ + X’ + I’ - br x-intercept = G’+X’+I’ slope = 1/b b = I/r IS x-intercept slope = s/b * * Y J W = S’ - sT’ + T’ + M’ + sY J = W

  16. What happens when there’s G’? Deriving the IS FunctionThree-Sector (w/ b = 0) Injection = WithdrawalI + G = S + T r J = I’ + G’ b = 0 = I/r slope =1/b =  IS: slope = s/b =  Y = x-intercept = * * J Y W

  17. What happens when there’s G’? Deriving the IS FunctionThree-Sector (w/ b = ) Injection = WithdrawalI + G = S + T r b =  = I/r slope = 1/b =0 r is a constant IS slope = s/b = 0 * * Y J W

  18. What happens when there’s G’? Deriving the IS FunctionThree-Sector (w/ s = 0) Injection = WithdrawalI + G = S + T r * * IS slope = s/b = 0 Y J S = S’ s = S/Y = 0 slope = 0 W = S’ + T’ W

  19. What happens when there’s G’? Deriving the IS FunctionThree-Sector (w/ s = ) Injection = WithdrawalI + G = S + T r IS slope = s/b =  * * Y J s= S/Y=  slope =  W

  20. What happens when there’s Ms’? Deriving the LM FunctionMs = Md = Ma + Mte = Liquidity Trap e = Ma/r = slope = 1/e = 0 r LM slope = d/e = 0 * * Y Ma Mt

  21. What happens when there’s Ms’? Deriving the LM FunctionMs = Md = Ma + Mtd = 0 r LM slope = d/e =0 * * Y Ma d = Mt/Y = 0 slope = 0 Mt

  22. What happens when there’s Ms’? Deriving the LM FunctionMs = Md = Ma + Mte = 0 r e = Ma/r = 0 slope = 1/e =  LM slope = d/e = * * Y Ma Mt

  23. What happens when there’s Ms’? Deriving the LM FunctionMs = Md = Ma + Mtd =  r LM slope = d/e =  * * Y Ma d = Mt/Y =  slope =  Mt

  24. Deriving the LM FunctionMs = Md = Ma + Mte =  when r  to a low level  liquidity trap r LM slope = d/e * * * LM slope = d/e = 0 Y Ma Mt

  25. 1990 A#13 Interest Rate MA0 MA1 • Which of the following correctly explains the rightward shift of the asset demand function from MA0 to MA1? A. a rise in the interest rate B. a rise in the marginal efficiency of investment C. an increase in the sale of government bonds D. a rise in the risk of holding bonds Asset demand for money

  26. 1990 A#30 • Refer to the diagram below: • Which of the following statements is INCORRECT? A. The expenditure multiplier will increase B. The IS curve will shift to the right. C. The average propensity to save will increase D. There will be a rise in realized injection S = saving I = investment G = government expenditure Y = income S, I, G S (I+G)’ I+G Y

  27. 1991 A#5 • A monetary policy will be more effective if the liquidity preference function is more ___ and the marginal efficiency of capital function is more ___ . A. elastic, elastic B. inelastic, inelastic C. inelastic, elastic D. elastic, inelastic

  28. 1991 A#8 • An increase in money supply will be likely to lead to an increase in national income. Which of the following would affect the extent of the change in national income? (1) the interest elasticity of investment (2) the marginal propensity of withdraw (3) the interest elasticity of demand for money A. (1) and (2) only B. (1) and (3) only C. (2) and (3) only D. All of the above

  29. 1992 A#2 • Which of the following will have a greater impact upon equilibrium income when there is a change in the money supply? A. the flatter the money demand curve; the steeper the investment demand curve; and the larger the MPC B. the steeper the money demand and investment demand curves; and the smaller the MPC C. the flatter the money demand and investment demand curves; and the larger the MPC D. the steeper the money demand curve; the flatter the investment demand curve; ;and the larger the MPC

  30. 1993 A#5 • There’re 3 hypothetical economies. They’ve different sets of IS and LM function IS Function LM Function Economy A Y = 1000 - 500r Y = 400 + 500r Economy B Y = 1800 - 200r Y = 500 + 500r Economy C Y = 2400 Y = 700 + 500r Suppose the central banks of the 3 economies reduce the money supply by the same amount. The national income will decrease most in __ and least in __. A. Economy A, Economy B B. Economy A, Economy C C. Economy B, Economy C D. Economy C, Economy A

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