IS curve & LM curve

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output
meaning in general
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the amount of something produced by a person, machine, or industry.
equilibrium
in general
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a state in which opposing forces or influences are balanced.
ECONOMICS a situation in which supply and demand are matched and prices stable.
"the market is in equilibrium"
equilibrium in the goods market
the IS relation.
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the condition that output - Y, be equal to the demand for goods, Z.
We called this condition the IS relation.
We define demand as
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the sum of consumption, investment, and government spending.
consumption was a function of disposable income (income minus taxes)
ivestement depends on
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The level of sales (production), the interest rate.
if the sales are rising, a firm needs to buy new machines, if they need a loan for it
an increase in output leads to
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to an increase in the demand for goods through an increase on consumption and investment
an increase in the interest rate leads to
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a decrease in output
first in the investment then in output
Equilibrium in the goods market implies that
the IS curve
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an increase in the interest rate leads to a decrease in output
An increase in taxes shifts the IS curve to
Shifts of the IS Curve
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the left
changes in taxes, T or government spending, G, shift the IS curve
Assumptions of short term analysis
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peri, od: up to one year, prices are rigid („sticky"), the productive resources of the economy are not fully employed, output is determined by demand
period of analysis, prices - including wages, „free resources" are available, firms produce as much as they can sell for given prices
The IS LM model focuses on
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on the relation between the interest rate and output in the short term
how changes in the interest rate i affect consumer expenditure
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The interes t rate determines costs of credit, affects the value of households’ wealth and the propensit y to save
propensit y to save with hig h er interest it becomes more profitable to delay consumption
the higher the interest rate, the lower the value of the consumer's health
The relation between consumption an the interest rate is
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negative, but weak;
consumption function depending on income: 𝐶=𝑐0+𝑐1 (1−𝑡𝑛)𝑌
if the household doesn't have enough money to cover its need they will borrow anyway, even with the high interest rates
Investment expenditure is ...... correlated with the interest rate
how
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negatively
Effects of interest rate on investemtn
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1. The interest rate determines costs of credit and the total costs of investment
3. The interest rate determines the opportunity cost of investment lost profits that could be received e.g. from bank deposits
2. Higher interest means higher cost of credit what makes future profits more heavily discounted
investment function
depending on the interest rate
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if interest rates 𝑖 raises investment 𝐼 falls but output Y grows
what is opportunity cost
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is the value of what you lose when you choose from two or more alternatives
When you invest, opportunity cost can be defined as the amount of money you might not earn by purchasing one asset instead of another.
Government expenditure G ... on the interest rate i
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does not depend
the interest rate for government loans 𝑖𝐺 may, but does not have to be equal to the market interest rate i
Net exports NX are ........ correlated with the interest rate
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negatively
a rise in i causes the domestic currency to appreciate, lowering the economy’s international competitiveness
The net export function
depending on income and interest rate
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the higher the income the higher the imports and imports enter the NX function with a minus, and increase in interest rate would cause the net export to decrease
NX= g - mY - ni
The LM curve
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includes all combinations of income and interest rate for which the money market is in equilibrium
Equilibrium in the money market is described by the following
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money demand has to be equal to money supply
in the money market the relation between the interest rate and income is...
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positive, because of the impact that income has on the money demand
real supply of money
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nominal supply of money divided by the level of prices of all the goods and services
it is not expressed in monetary terms but in physical units like kg etc
the calculation shows how many goods and services can be bought by all the money in circulation
the impact of the level of income on interest rates
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if the level of income is higher than before intrest rate has to increase
if the money supply increases LM function is moved to the
which direction
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right (downwards)
money supply can increase as a decision from the central bank or as a result in the change of the price level

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