ISLMsummary - graph and notes on ISLM model PDF

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graph and notes on ISLM model...

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Co-determination of output and the interest rate

IS Relation:

Δi

Intuition:

Investment Demand

i

by the clearing of

goods & financial markets

ΔY Y

: i increases, investment more costly, investment demand Decreases, when demand decreases, output decreases

: i and Y are (-)ly correlated: Downward sloping IS Algebra: 1

𝑌 = (1−𝑐

1 −𝑏1)

𝑌 = 𝐶(𝑌, 𝑇) + 𝐼(𝑌, 𝑖) + 𝐺

[goods market equilibrium]

[𝑐0 − 𝑐1 𝑇 + 𝑏0 − 𝑏2 𝑖 + 𝐺] [derived from above equilibrium condition]

Graph:

LM Relation:

ΔY

Intuition:

𝑀𝑑

Y

Δi i

: Income increases, which leads to more money demand Higher money demand pushed interest rates up in money market : Y and i are (+)ly correlated: Upward sloping LM curve Algebra:

𝑀/𝑃 = 𝑌𝐿(𝑖) [financial market equilibrium] 𝑖 = 𝑎𝑌 − 𝑑

Graph:

[derived from above equilibrium condition]

Co-determination of output and the interest rate

by the clearing of

goods & financial markets

Notes: IS curve gives (i and Y) combinations that clear goods market Within goods market i and Y move in opposite direction, therefore IS has (-) slope The linking variable is investment demand

LM curve gives (i and Y) combinations that clear financial markets Within financial markets i and Y move in same direction, therefore LM has (+) slope The linking variable is money demand...