The goods and money market in a closed economy: The IS-LM

The goods and money market in a closed economy The IS-LM

Model Dr Osakede

Bowen University

Closed economy

bull The IS-LM model in a closed economy is based on the assumption that the economy does not interact with the rest of the world That is there is no international trade or export and import

The IS and LM relation

The goods market the IS curve

bull Demand for goods C(YD) + I + G

bull where YD = Y 1048576 T is the disposable income

bull Supply of goods Y

bull Equilibrium Y = C(Yd) + I + G

The goods market Investment

bull Investment is not constant It depends primarily on two factors

bull Production (+)

bull Interest rate (-)

bull the higher the interest rate the more expensive it is to borrow

bull in order to invest the lower the level of investment

bull Investment function I = I (Y i )

(+-)

The goods market Determining output

bull The demand for goods is C (Y T) + (Y i ) + G(+-) (+-)

the demand for goods is increasing in Y (incomeproduction)


The goods market IS relation


The goods market IS relationbull Effect of increase in the interest rate

The goods market IS relationbull Construction of the IS Curve


The goods market Shifts in the IS curve bull Change in taxes


The goods market Shifts in the IS curve bull Shifts in other components

The moneyfinancial market LM curve


Equilibrium MS = MD = M = NYL(i)

The moneyfinancial market LM Relation




The moneyfinancial market Shifts of the LM Curve



The IS-LM Model Equilibrium

The IS-LM Model Fiscal Policy





The IS-LM Model Monetary Policy





The IS-LM Model Monetary and Fiscal Policy

The IS-LM Model Policy Mix

bull The combination of fiscal and monetary policy is called the policy mix


bull With fiscal contraction (fall in government spending) the IS curve shifts downward from IS to ISrsquo and equilibrium with the LM moves to Arsquo with a lower output level Yrsquo This implies a lower interest rate even in the money market To restore equilibrium due to shift in the IS that is to maintain the same level of interest rate at i0 the LM curve has to shift outward to make interest rate rise and for this to happen there has to be a contractionary monetary policy that reduces money supply


Closed economy

bull The IS-LM model in a closed economy is based on the assumption that the economy does not interact with the rest of the world That is there is no international trade or export and import









bull Production (+)





(+-)
















































bull Production (+)





(+-)















































bull Production (+)





(+-)










































bull Production (+)





(+-)










































































































































































































































































































































































































































































































































































































































































































































Documents

The goods and money market in a closed economy: The IS-LM