Keynesian Economics and IS-LM - topic 8

multiplier effect formula

M= 1/(1-MPC)

MPC

marginal propensity to consume

marginal propensity to consume

the fraction of extra income that a household consumes rather than saves

marginal propensity to save

the fraction of extra income that households saves rather than consumes

multiplier effect - all withdrawals formula

M= 1/MPS + MPT + MPM

the effect of a change is fiscal policy

an increase in government spending and a reduction in taxes would both push the IS curve out to the right

the effect of a change in monetary policy

an increase in money supply shifts the LM curve to the right

what causes the a new equilibrium to occur on the IS curve

a fall in the interest rate which raises the the expenditure line

what causes the a new equilibrium to occur on the LM curve

a rise in national income which increases the demand for money

what does the IS and LM curves describe

equilibrium in goods market and money market and together determines the general equilibrium in the economy

IS

investment and saving

LM

liquidity and money

what links the goods and money markets

the rate of interest (i)

when interest rates go down

the level of national income goes down, and investmnet increases because its cheaper to borrow money

IS curve 2 axis

y axis - interest rate, x -axis - national income

every single point on the IS curve

can be traced back to a point of equilibrium in the goods market (keynsian cross)

slope of the IS curve depends on

how responsive consumption and investment expenditures are to changes in interest rates

the more responsive C and I are….

the flatter the IS curve

The IS curve represents

the combinations of interest rates and real GDP at which the goods market is in equilibrium

the LM curve represents

the combinations of interest rates and real GDP at which the money market is in equilibrium

in the IS-LM model a reduction in autonomous expenditure such as gov spending

leads to a leftward shift of the IS curve because lower government spending decreases aggregate demand, leading to a decrease in output at any given interest rate. The LM curve remains unchanged unless there is a corresponding change in monetary policy.

shifts in IS curve

autonomous expenditure, exports, expectations

shifts in IS curve direction

fall in any of the changes - left, rise in changes - right

axis’s for the money market

y- interest rate, x - quantity of money

what will cause the LM curve to shift

if the CB expands or contracts the money supply

rise in money supply effect on LM curve

shift downwards to the right

equilibrium in the economy is found where

the IS curve intersects the LM curve, interest rate Ie and national income level Ye

effect of a change in fiscal policy

shifts the IS curve out to the right/ left

effect of change in monetary policy

shifts LM curve to the right or left ( expansion shifs it to the right

if CB’s want to maintain interest rates following a shift in the Is curve

they must increase the money supply and shift the LM curve to the right