ECO3200 Chap 11

Interest Rates

Represent the cost of borrowing money; affect aggregate spending and investment demand.

IS-LM Model

A core model in short-run macroeconomics that shows the relationship between interest rates and output in the goods and money markets.

Investment Function (I=I̅-bi)

A function where I is the level of investment, I̅ is autonomous investment, b is the responsiveness of investment to interest rates, and i is the interest rate.

IS Curve

A curve that shows combinations of interest rates and output levels where planned spending equals income.

AD Shift

A change in aggregate demand, which occurs when there's an increase in interest rates, causing a leftward shift in the AD curve.

Marginal Propensity to Consume (c)

The percentage of additional income that people will spend on consumption.

Demand for Money (L=kY-hi)

A formula that reflects the demand for real money balances, dependent on real income (Y) and interest rate (i).

LM Curve

A curve that shows combinations of interest rates and output levels where money demand equals money supply.

Autonomous Spending

Expenditures that are independent of current income levels; depicted as A̅ in the IS-LM model.

Equilibrium in the Money Market

Occurs when the quantity of money demanded equals the quantity of money supplied, resulting in the LM curve.

Slope of the IS Curve

Determined by how responsive investment spending is to changes in interest rates and the multiplier effect.

Real Money Supply

The amount of money in circulation adjusted for the price level, denoted as M̅/P̅.

Effect of an Increase in Money Supply

Shifts the LM curve down and right, leading to lower interest rates and higher income levels.

Equilibrium Levels of Income and Interest Rate

Change when either the IS or LM curve shifts, impacting the overall economy.

Downward Sloping IS Curve

Illustrates the negative relationship between the interest rate and output (Y) for a given level of autonomous spending.

Inverse Relationship Between Money Demand and Interest Rates

As interest rates increase, the quantity of money demanded decreases.

Equilibrium Point in the Money Market (E)

Where the demand for real balances equals the supply of money, represented as a point on the LM curve.

Sensitivity of Investment Spending

How responsive investment is to changes in interest rates, affecting the slope of the IS curve.