Transcript IS-LM MODEL

IS-LM MODEL
Miscellaneous
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Simple Keynesian Model v.s.
IS-LM Model G’ (b = 0)
C, I, G, G’, AD
Slope = s/b = 
r
b = I/r = 0
IS1
Y
(C’-cT’+I’+G’)/s
(C’-cT’+I’+G’)/s
IS2
LM
Y
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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

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Simple Keynesian Model v.s.
IS-LM Model G’ (b  0)
C, I, G, G’, I’,AD
r
Slope = s/b
IS1
IS2
Y
Y
(C’-cT’+I’+G’)/s
LM
(C’-cT’+I’+G’)/s
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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,
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 the IS-LM multiplier = Ye/ G’ =
s+b (d/e)
 crowding-out effect

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Simple Keynesian Model v.s.
IS-LM Model G’ (e = )
C, I, G, G’, AD
Slope = d/e = 0
r
IS1 IS2
e = Ma/r = 
Liquidity Trap
d = Mt/Y = 0
LM
Y
(C’-cT’+I’+G’)/s
(C’-cT’+I’+G’)/s
Y
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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. 7
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,
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there’s no crowding-out effect.
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
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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
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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
IS1 IS3 IS2
Y
(C’-cT’+I’+G’)/s
(C’-cT’+I’+G’)/s
LM
Y
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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
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Demand Curve
P
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
Qd
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Deriving the IS Function
Two-Sector
Injection = Withdrawal
I=S
I= I’ - br
r
IS
y-intercept =I’/b
*
y-intercept = I’/b
x-intercept = I’
x-intercept = I’/s
slope =1/b
slope = s/b
b = I/r
I
*
Y
C’ = 0 = S’
S = sY
slope = s
s =S/Y
J=W
I=S
S
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Deriving the IS Function
Four-Sector
Injection = Withdrawal
I+G+X=S+T+M
J = G’ + X’ + I’ - br
x-intercept = G’+X’+I’
slope = 1/b
r
*
IS
x-intercept
slope = s/b
b = I/r
* Y
J
W = S’ - sT’ + T’ + M’ + sY
J=W
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Deriving the IS Function
Three-Sector (w/ b = 0)
Injection = Withdrawal
I+G=S+T
J = I’ + G’
What happens when
there’s G’?
r
b = 0 = I/r
IS:
*
*
slope =1/b = 
J
slope = s/b = 
Y=
x-intercept =
Y
W
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Deriving the IS Function
Three-Sector (w/ b = )
Injection = Withdrawal
I+G=S+T
b =  = I/r
r
slope = 1/b =0
What happens when
there’s G’?
IS
slope = s/b = 0
r is a constant
*
*
Y
J
W
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Deriving the IS Function
Three-Sector (w/ s = 0)
Injection = Withdrawal
I+G=S+T
r
*
What happens when
there’s G’?
*
IS
slope = s/b = 0
Y
J
S = S’
s = S/Y = 0
slope = 0
W
W = S’ + T’
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Deriving the IS Function
Three-Sector (w/ s = )
Injection = Withdrawal
I+G=S+T
What happens when
there’s G’?
r
*
IS
slope = s/b = 
*
Y
J
s= S/Y= 
slope = 
W
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Deriving the LM Function
Ms = Md = Ma + Mt
e=
Liquidity Trap
e = Ma/r =
slope = 1/e = 0
What happens when
there’s Ms’?
LM
r
slope = d/e = 0
*
*
Y
Ma
Mt
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Deriving the LM Function
Ms = Md = Ma + Mt
d=0
r
What happens when
there’s Ms’?
LM
slope = d/e =0
*
*
Y
Ma
d = Mt/Y = 0
Mt
slope = 0
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Deriving the LM Function
Ms = Md = Ma + Mt
What happens when
e=0
there’s Ms’?
e = Ma/r = 0
r
slope = 1/e = 
*
LM
slope = d/e =
*
Y
Ma
Mt
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Deriving the LM Function
Ms = Md = Ma + Mt
d=
What happens when
there’s Ms’?
r
LM
slope = d/e = 
*
*
Ma
Y
d = Mt/Y = 
Mt
slope = 
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Deriving the LM Function
Ms = Md = Ma + Mt
e =  when r  to a low level  liquidity trap
r
LM
slope = d/e
*
**
Ma
Mt
LM
slope = d/e = 0
Y
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1990 A#13
Interest Rate
MA0
MA1
Asset demand for money
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
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1990 A#30

Refer to the diagram below:
S, I, G
S = saving
S
I = investment
G = government expenditure
(I+G)’
Y = income
I+G
Y
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

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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
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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
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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 29
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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