Chapter 5: The Analysis of IS- LM Model Gang Gong March 14. 2002 Copyright Notes: This electronic file is only used as a lecture notes for the student in this class. It is not allowed to be used for presentation anywhere else without the permission from the author
Chapter 5: The Analysis of ISLM Model Gang Gong March 14, 2002 Copyright Notes:This electronic file is only used as a lecture notes for the student in this class. It is not allowed to be used for presentation anywhere else without the permission from the author
Introduction The objective of this chapter is to put the 2o previously discussed two models-the models of product market and money market --together and discuss how output and interest rate is determined The model presented in this chapter is often called the IS-LM model (Is: the product o market model, LM the money market model)
Introduction • The objective of this chapter is to put the previously discussed two models -- the models of product market and money market --together and discuss how output and interest rate is determined • The model presented in this chapter is often called the IS-LM model (IS: the product market model; LM the money market model)
p Investment Determination 5 In chapter 3, we have assumed that y 2 investment is autonomous and thus it is simply given. This is certainly not satisfying For a complete model of output determination, we need to discuss how investment is determined
Investment Determination • In chapter 3, we have assumed that investment is autonomous and thus it is simply given. This is certainly not satisfying. For a complete model of output determination, we need to discuss how investment is determined
p Investment Determination 5 The determination of investment is one ofy the most complicated issue in 02 macroeconomics. You can list as many as possible factors that could affect investment Empirically, the investment function is the y most difficult one to be estimated . y
Investment Determination • The determination of investment is one of the most complicated issue in macroeconomics. You can list as many as possible factors that could affect investment. Empirically, the investment function is the most difficult one to be estimated
p Investment Determination 5 Yet there is no doubt that investment 2o2 Should depend on interest rate. Ifinterest 5 rate increase. investment should decrease Why?(to be expressed in the class)
Investment Determination • Yet, there is no doubt that investment should depend on interest rate. If interest rate increase, investment should decrease. Why? (to be expressed in the class)
p Investment Determination 5 Therefore, we could have a simple 2o 2 investment function, which could be written as x=f()2 where f<0
Investment Determination • Therefore, we could have a simple investment function, which could be written as I=f(i) where f ’<0
The Is Curve could be written as 多Y=C++G =A+C(Y-1)+f(1)+G [A+f()+G] 1-c(1-t)
The IS Curve • Given the investment function, the equilibrium condition in product market could be written as [ ( ) ] 1 (1 ) 1 ( ) ( ) A f i G c t A c Y t Y f i G Y C I G + + − − = = + − + + = + +
The Is Curve It can easily be detected that there is a As negative relation between interest rate and income. A curve that reflect such a relation is called IS(standing for investment and saving)curve. It represents the equilibrium condition in the product market (see the graph presented in class)
The IS Curve • It can easily be detected that there is a negative relation between interest rate and income. A curve that reflect such a relation is called IS (standing for investment and saving) curve. It represents the equilibrium condition in the product market (see the graph presented in class)
b The LM Curve We are now considering the equilibrium a 2 condition in money market. This can be 2> written as kYh证=M
The LM Curve • We are now considering the equilibrium condition in money market. This can be written as k Y − hi = M
b The LM Curve .It can easily be detected that there is a i 7o positive relation between interest rate and sv income for a given my money supply. A curve that reflects such a relation is called LM (Standing for liquid and money) curve y (see the graph presented lin class). x
The LM Curve • It can easily be detected that there is a positive relation between interest rate and income for a given my money supply. A curve that reflects such a relation is called LM (standing for liquid and money) curve (see the graph presented in class)
