Is-LM-Analysis 17 March 2010

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    ISLM analysisISLM analysis

    EquilibriumEquilibrium

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    O

    Rateofintere

    st

    National income

    LM

    IS

    Equilibrium in both the goods and money marketsEquilibrium in both the goods and money markets

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    O

    Rateofintere

    st

    National income

    IS

    Y1

    a

    Assume that national income

    is currently at a level ofY1

    LM

    Equilibrium in both the goods and money marketsEquilibrium in both the goods and money markets

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    O

    Rateofintere

    st

    National income

    IS

    r1

    Y1

    a

    This gives a rate of

    interest ofr1 (point a)

    LM

    Equilibrium in both the goods and money marketsEquilibrium in both the goods and money markets

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    O

    Rateofintere

    st

    National income

    IS

    r1

    Y1 Y2

    a

    Butat r1, national income

    is below the goods market

    equilibrium level (Y2)

    b

    LM

    Equilibrium in both the goods and money marketsEquilibrium in both the goods and money markets

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    Butas income rises, so there

    will be a movement up the

    LMcurve. The interest rate

    will rise, thereby reducing

    national income below Y2.

    O

    Rateof

    intere

    st

    National income

    IS

    r1

    Y1 Y2

    a b

    LM

    Equilibrium in both the goods and money marketsEquilibrium in both the goods and money markets

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    O

    Rateof

    intere

    st

    National income

    IS

    re

    Ye

    LM

    Equilibrium in both the goods and money marketsEquilibrium in both the goods and money markets

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    ISLM analysisISLM analysis

    ISLM analysis ofchanges in goods

    and money markets

    ISLM analysis ofchanges in goods

    and money markets

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    O

    Rateof

    intere

    st

    National income

    LM

    IS

    r1

    Y1

    ISLManalysis of changes in the goods and money marketsISLManalysis of changes in the goods and money markets

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    O

    Rateof

    intere

    st

    National income

    IS1

    r1

    Y1

    IS2

    r2

    Y2

    A rise ininjections

    LM

    ISLManalysis of changes in the goods and money marketsISLManalysis of changes in the goods and money markets

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    O

    Rateof

    intere

    st

    National income

    LM1

    IS

    r1

    Y1

    LM2

    r3

    Y3

    A rise in themoney supply

    ISLManalysis of changes in the goods and money marketsISLManalysis of changes in the goods and money markets

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    LM2LM1

    O

    Rateof

    intere

    st

    National income

    IS1

    r1

    Y1

    IS2

    Y4

    A rise in both

    injections and

    money supply

    ISLManalysis of changes in the goods and money marketsISLManalysis of changes in the goods and money markets

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    ISLM analysisISLM analysis

    Deriving an AD curve

    from an ISLM diagram

    Deriving an AD curve

    from an ISLM diagram

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    Rateof

    interes

    t(r

    )

    Pricele

    vel(P

    )

    National income (Y)

    National income (Y)

    LM1

    IS

    Y1

    r1

    P1

    Deriving theAD curve from an ISLMdiagramDeriving theAD curve from an ISLMdiagram

    Y1

    a'

    a

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    Rateof

    in

    teres

    t(r

    )

    Pricele

    vel(P

    )

    National income (Y)

    LM1LM2

    IS

    AD

    Y1

    Y1Y2

    r2

    r1

    P2

    P1

    Deriving theAD curve from an ISLMdiagramDeriving theAD curve from an ISLMdiagram

    a'

    a

    Y2

    b'

    b

    National income (Y)

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    ISLM analysisISLM analysis

    ISLM analysis offiscal and

    monetary policy

    ISLM analysis offiscal and

    monetary policy

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    O

    Rateof

    intere

    st

    National income

    LM

    IS

    r1

    Y1

    ISLManalysis of fiscal and monetary policyISLManalysis of fiscal and monetary policy

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    O

    Rateof

    intere

    st

    National income

    IS1

    r1

    Y1

    IS2

    r2

    Y2

    Expansionary

    fiscal policy

    LM

    ISLManalysis of fiscal and monetary policyISLManalysis of fiscal and monetary policy

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    LM2LM1

    O

    Rateof

    intere

    st

    National income

    IS1

    r1

    Y1

    IS2

    Y4

    Expansionary

    fiscal and

    monetary policy

    ISLManalysis of fiscal and monetary policyISLManalysis of fiscal and monetary policy

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    ISLM analysisISLM analysis

    Keynesian analysis offiscal and

    monetary policy

    Keynesian analysis offiscal and

    monetary policy

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    O

    Rateof

    intere

    st

    National income

    LM

    IS1Y1

    IS2

    Y2

    Expansionary

    fiscal policy

    Keynesian analysis of fiscal and monetary policyKeynesian analysis of fiscal and monetary policy

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    O

    Rateof

    intere

    st

    National income

    LM1

    ISY1Y2

    Expansionarymonetary policy

    LM2

    Keynesian analysis of fiscal and monetary policyKeynesian analysis of fiscal and monetary policy

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    ISLM analysisISLM analysis

    Monetarist analysis offiscal and

    monetary policy

    Monetarist analysis offiscal and

    monetary policy

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    O

    Rateof

    intere

    st

    National income

    LM

    IS1

    Y1Y2

    Expansionary

    fiscal policy

    IS2

    Monetarist analysis of fiscal and monetary policyMonetarist analysis of fiscal and monetary policy

    f f

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    O

    Rateof

    intere

    st

    National income

    LM1

    IS

    Y1 Y2

    Expansionary

    monetary policy

    LM2

    Monetarist analysis of fiscal and monetary policyMonetarist analysis of fiscal and monetary policy

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    Fiscal Policy, the Interest Rate and the IS CurveFiscal Policy, the Interest Rate and the IS Curve

    The Effects of anThe Effects of an

    Increase in TaxesIncrease in Taxes

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    Monetary Policy, the Interest Rate, and the LM CurveMonetary Policy, the Interest Rate, and the LM Curve

    sMonetary contraction(tightening) refers to a decreasein the money supply.

    s

    An increase in the moneysupply is called monetaryexpansion.

    sMonetary policy affects onlythe LMcurve, not the IScurve.

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    Monetary Policy, the Interest Rate, and the LM CurveMonetary Policy, the Interest Rate, and the LM Curve

    The Effects of aThe Effects of a

    Monetary ExpansionMonetary Expansion