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Semester 2
The
IS/LM model, introduced by Sir John Hicks to explainSession
a 2014-2015
major part of Keynesian macroeconomics since 1937
Learning outcomes
Money market
IS
LM
IS-LM model
How the goods market and the money market combine to set up the
overall equilibrium of the economy?
The process of adjustments that integrates the markets for overall
equilibrium.
The limitations of the IS-LM model.
The tools of monetary and fiscal policies for use in the following chapters.
Product market
9-1
IS-LM Model
This topic focus on the development of the ISLM model, the basis of the AD curve.
But focus on the short run and assume the price
level is fixed (so, SRAS curve is horizontal).
Focus on the closed-economy case.
slide 5
slide 6
5/10/2016
Keynesian cross
contains two lines
demand
Y = AD
1. 45-degree line
diagram - A simple
closed economy model
in which income is
determined by
expenditure
Desired total
spending (or
aggregate
expenditure,
or "aggregate
demand")
supply
Ignore AS
Assume prices or inflation fixed for businesscycle analysis,
No financial markets
Ignore rest of the world (Closed economy)
slide 8
E=Y
E=C+I(r1)+G
E=C+I(r2)+G
Y2
r
Y1
r
S(Y1)
r2
r1
I(r)
I(r2)
I(r1)
r2
r1
r1
r2
IS
Y2
Y1
S(Y2)
r1
I(r)
r2
I
IS
Y1
Y2
by three motives:
transactions motive for basic transactions (YL)
precautionary motive for unexpected problems/ costs (YL)
speculative motive due to speculation on interest rate
slide 12
5/10/2016
DerivingtheLM curve
(a) The market for
r
LM
r2
r1
r2
L ( r , Y2 )
r1
L ( r , Y1 )
M/P
Y1
9-13
The LM Curve
LM2
LM1
r2
r2
r1
L ( r , Y1 )
r1
M/P
Y2
Y1
9-15
IS-LM Model
Relationship between I (Investment) and r (real interest rate)
Developing IS curve (IS represents E in goods market)
I-driven (the Keynesian cross)
S-driven (loanable fund model)
IS-LM, the basis of AD curve (How to derive AD curve from IS-LM model)
9-17
5/10/2016
LM2
LM1
r2
r2
r1
L ( r , Y1 )
M/P
r1
Y1
PReal money supply curve shift to the leftrLM curve shift to left
CHAPTER 11
LM(P2)
LM(P1)
r2
r1
IS
Y2
Y1
Y2
Y1
P2
P1
Aggregate Demand II
AD
Y
slide 20