Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium:...
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Transcript of Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium:...
![Page 1: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/1.jpg)
Chapter 4 Money, Interest, and Income
![Page 2: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/2.jpg)
The goods market and the IS curve
Goods market equilibrium:
Investment and the interest rate:Relaxing the assumption of exogenously
determined investment spending;The linkage between investment and interest rate:
Firms borrow to purchase investment goods; Higher interest rate discourages investment.
0 1 (1 ) 1 (1 )
A C cTR I GY
c t c t
![Page 3: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/3.jpg)
The goods market and the IS curve
The investment demand schedule:
0I I bi b
![Page 4: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/4.jpg)
The goods market and the IS curve
The interest rate and aggregate demand: The IS curve
(1 )
AD C I G
cTR c t Y I bi G
A cY bi
Y AD A cY bi
1
A biY
c
![Page 5: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/5.jpg)
The goods market and the IS curve
Derivation of the IS curve.
![Page 6: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/6.jpg)
The goods market and the IS curve
The slope of the IS curve. Larger b implies flatter
IS curve; Larger multiplier
implies flatter IS curve.
![Page 7: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/7.jpg)
The goods market and the IS curve
The position of the IS curve. Higher autonomous
spending shifts the IS curve to the right;
The horizontal shift equals the multiplier times the increase in autonomous spending.
![Page 8: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/8.jpg)
The goods market and the IS curve
Positions off the IS curve: E3 v.s. E1:
Same income but lower interest rate;
Excess demand for goods.
E4 v.s. E2: Same income but higher
interest rate; Excess supply of goods.
![Page 9: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/9.jpg)
The assets market and the LM curve Two types of assets:
Bonds: interest bearing;Money: no interest bearing.
The wealth constraint:An individual has to allocate his financial wealth
between bonds and money. Real and nominal money:
Nominal money: the dollar value;Real money: nominal money divided by the price
level.
![Page 10: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/10.jpg)
The assets market and the LM curve
The demand side:
The accounting identity:
The assets market equilibrium:
The bond market is equilibrated whenever the money market is.
WNL DB
P
M WNSB
P P
( ) 0M
L DB SBP
![Page 11: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/11.jpg)
The assets market and the LM curve The demand for money:
Households demand real balances instead of nominal money;
Why or why not hold money? Benefit: convenience; Cost: interest.
Determinants of real money demand: Real income: higher income implies more expenditure
hence more exchange needs; Interest rate: higher interest rate implies greater cost.
, 0L kY hi k h
![Page 12: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/12.jpg)
The assets market and the LM curve
Demand for money.
![Page 13: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/13.jpg)
The assets market and the LM curve
The supply of money, money market equilibrium, and the LM curve:The nominal quantity of money is set by the
Federal Reserve;Assuming for now that the price level is fixed;Money market equilibrium:
MkY hi
P
![Page 14: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/14.jpg)
The assets market and the LM curve
Derivation of the LM curve.
![Page 15: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/15.jpg)
The assets market and the LM curve
The slope of the LM curve:Larger k: steeper LM curve;Larger h: flatter LM curve.
The position of the LM curve:Increase real money supply and the LM curve
shifts outward.
![Page 16: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/16.jpg)
The assets market and the LM curve An increase in money supply shifts the LM curve to
the right.
![Page 17: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/17.jpg)
The assets market and the LM curve Positions off the LM curve:
E4 v.s. E1: larger income and excess demand for money;
E3 v.s. E2: lower income and excess supply of money.
![Page 18: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/18.jpg)
Equilibrium in the goods and assets markets The intersection of the IS and LM curves represents
equilibrium on the goods and assets markets.
![Page 19: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/19.jpg)
Equilibrium in the goods and assets markets Effects of an increase in autonomous spending on
income and the interest rate.
![Page 20: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/20.jpg)
Adjustment toward equilibrium Assumptions:
Output increases whenever there is excess demand for goods and declines whenever there is excess supply of goods;
The interest rate rises whenever there is excess demand for money and falls whenever there is excess supply of money;
The speed of convergence is constant in both markets.
![Page 21: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/21.jpg)
Adjustment toward equilibrium The assets market adjusts quickly.
![Page 22: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/22.jpg)
Adjustment toward equilibrium The goods market adjusts quickly.
![Page 23: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/23.jpg)
Adjustment toward equilibrium The speeds of convergence are comparable.
![Page 24: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/24.jpg)
A formal treatment of the IS-LM model IS schedule:
LM schedule:
The equilibrium solution:
( )GY A bi
1 Mi kY
h P
0 0
1
G
b M k MY A i A
h P h h kb P
1 /G
Gk b h
![Page 25: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/25.jpg)
A formal treatment of the IS-LM model The fiscal policy multiplier:
The multiplier is smaller than G;
Higher income implies higher interest rate, crowding out private investment;
Fiscal policy is weak for large b and k, or small h.
0
1 /G
G
Y
G k b h
![Page 26: Chapter 4 Money, Interest, and Income. The goods market and the IS curve Goods market equilibrium: Investment and the interest rate: Relaxing the assumption.](https://reader035.fdocuments.in/reader035/viewer/2022070400/56649f0d5503460f94c21af3/html5/thumbnails/26.jpg)
A formal treatment of the IS-LM model The monetary policy multiplier:
Monetary policy is strong with small h and k, or large b and G.
0
( / )
Y b
M P h