Download The IS Curve

Chapter 24
Linking the Financial
System and the
Economy: The
IS-LM-FE Model
A Model for Goods and Assets
Markets: Assumptions
• General equilibrium occurs when all the
markets are in simultaneous equilibrium.
• The goods market includes trade in all goods
and services that the economy produces.
• The money market includes trade in all
assets used as the medium of exchange.
• Nonmoney asset market includes trades of
nonmonetary assets that are stores of value.
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-2
The IS Curve
• The goods market is in equilibrium
when Y = C + I + G.
• When the goods market is in
equilibrium, national saving equals
national investment.
• The IS curve summarizes the
equilibrium in the goods market.
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-3
Determinants of National Saving
• National saving increases when current
income or current output rise.
• A rise in expected future income causes
national saving to fall.
• National saving increases with the interest
rate, although the effect probably isn’t large.
• Holding current output constant, an increase
in government purchases reduces saving.
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-4
Determinants of National Investment
• An increase in expected future
profitability of capital increases
investment.
• An increase in the expected real interest
rate lowers the demand for investment.
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-5
Figure 24.1 The IS Curve Graph
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-6
Figure 24.2 Excess Demand and
Supply in the Goods Market
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-7
Table 24.1
Accounting
for Shifts
of the IS
Curve
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-8
Determining Output:
The Full Employment Line
• Full-employment output is the
production level when all production
factors are used.
• On the IS diagram, full employment is
represented as a vertical line at Y *.
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-9
Table 24.2 Accounting for Shifts of
the FE Line
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-10
The LM Curve
• In the asset market: Md + Nd = Ms + Ns.
• Equilibrium in the nonmoney asset
market implies equilibrium in the money
market.
• The LM curve is the set of combinations
of current output and the real interest
rate for which the money market is in
equilibrium.
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-11
Figure 24.4 The LM Curve Graph
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-12
Figure 24.5 Points Off the LM Curve
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-13
Table 24.3
Factors
Shifting
the LM
Curve
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-14
The IS-LM-FE Model
• The financial and goods market are both in
equilibrium when IS, FE, and LM intersect.
• The economy will restore equilibrium if the IS
curve, the LM curve, or the FE line shifts.
• The neutrality of money implies that a onetime change in the nominal money supply
affects only nominal variables.
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-15
Figure 24.7 Changing the Equilibrium
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-16
Figure 24.8 Price Level Adjustment
to Restore Equilibrium
Copyright © 2005 Pearson Addison-Wesley. All rights reserved.
24-17