IS=LM model

z

what does the IS curve represent

Investment- savings

represents equilibrium in the goods and services market

what does the LM curve represent

Liquidity-money

represents equilibrium in the money market

what does the IS and LM curves determine

the position and slope of the AD curve and thus the short run national income.

What does Keyenes believe total income is determined by in the short run

the spending plans of households firms and the government

where do differences between planned expernature and GDP arise from

unplanned inventory investment.

what is the slope of the planned expenditure line

the MPC (marginal propensity to consume)

what degree angle is the actual expenditure line

45º

this is because it is where PE=GDP

meaning that when the y axis planned expenditure is 10, GDP also is 10. creating a straight line at 45º.

what equation should be true when the Keynesian cross is in equilibrium and why

Y = C(Y-T) + I + G

(with the second Y, I and G being fixed)

this is because the actual expenditure curve is PE=Y

and the planned expenditure curve is PE= C(Y-T) + I + G

so when they equate each other on the graph, thus new equation is formed.

what is the government purchases multiplier and what does it mean

1/1-MPC

it is how much the total national income increases when the gov increases spending

what key factor is treated as exogenous, meaning,..

investment.

meaning that I( r) is subbed into the equation.

this thus means that planned expenditure depends on what 2 factors

income (Y) and real interest rate (r )

what 2 graphs are thus used to derive the IS curve

the Keynesian cross (income) and the investment function (real interest rate)

what causes the IS curve to shift

changes in planned expenditure- usually caused by a change in fiscal policy.

what is the equation for the supply of real money balances

and what does this mean

(M/P)^s = M/P (both fixed)

the supply of real money balances is fixed.

why are both fixed?

M is fixed as it is set exogenously by the central bank

P is fixed in the short run as prices are sticky.

how can the central bank change interest rates

change the money supply-

• the bank decreases the money supply→ shortage of money → interest rates rise

• bank increases money supply → excess of money → interest rate falls

what 2 factors does money demand depend on

income and interest rate

so, what does the LM curve have on its axis

interest rate and income.

what does the LM curve show

the changes in equilibrium in the money market- caused by these 2 factors

the IS and LM curves are shifted by

IS- fiscal policy

LM- money supply changes.