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Money, The Interest Rate, and Output: Analysis and Policy: Appendix: The IS-LM Diagram
Money, The Interest Rate, and Output: Analysis and Policy: Appendix: The IS-LM Diagram
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair
The Goods Market
and the Money Market
Money, the Interest Rate, and Output:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 3 of 29
The Links Between the Goods
Market and the Money Market
Money, the Interest Rate, and Output:
depends on income.
C H A P T E R 12:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 4 of 29
Link 1: Income and
the Demand for Money
Money, the Interest Rate, and Output:
• Income, which is
determined in the goods
market, has considerable
Analysis and Policy
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 5 of 29
Link 2: Planned Investment
and the Interest Rate
Money, the Interest Rate, and Output:
effects on planned
investment in the goods
market.
• When the interest rate
C H A P T E R 12:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 6 of 29
Investment, the Interest Rate
and the Goods Market
Money, the Interest Rate, and Output:
Analysis and Policy
• An increase in the
interest rate from 3
percent to 6 percent
lowers planned aggregate
C H A P T E R 12:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 8 of 29
Money Demand, Aggregate Output
(Income), and the Money Market
Money, the Interest Rate, and Output:
• Changes in aggregate
output (income), which
take place in the goods
Analysis and Policy
Y M d
r
Y M d
r
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 9 of 29
Expansionary Policy Effects
Money, the Interest Rate, and Output:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 10 of 29
The Crowding-Out Effect
Money, the Interest Rate, and Output:
Analysis and Policy
• The crowding-out
effect is the tendency
for increases in
C H A P T E R 12:
government spending
to cause reductions in
G Y M d
r I private investment
spending.
Y increases less than if r did not increase
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 11 of 29
The Crowding-Out Effect
Money, the Interest Rate, and Output:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 12 of 29
Expansionary Monetary Policy:
An Increase in the Money Supply
Money, the Interest Rate, and Output:
M s
r I Y M d
r decreases less than if Md did not increase
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 13 of 29
Fed Accommodation of an
Expansionary Fiscal Policy
Money, the Interest Rate, and Output:
• An expansionary fiscal
policy (higher government
spending or lower taxes) will
Analysis and Policy
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 14 of 29
Fed Accommodation of an
Expansionary Fiscal Policy
Money, the Interest Rate, and Output:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 15 of 29
Contractionary Policy Effects
Money, the Interest Rate, and Output:
• Contractionary fiscal
policy refers to a
decrease in
Analysis and Policy
government spending
or an increase in net
taxes aimed at
decreasing aggregate
output (income) (Y).
C H A P T E R 12:
G or T Y
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 16 of 29
Contractionary Fiscal Policy
Money, the Interest Rate, and Output:
• The decrease in Y is
smaller when we take
the money market into
Analysis and Policy
account.
C H A P T E R 12:
G or T Y M d
r I
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 17 of 29
Contractionary Monetary Policy
Money, the Interest Rate, and Output:
• Contractionary monetary
policy refers to a decrease
in the money supply aimed
Analysis and Policy
at decreasing aggregate
output (income) (Y).
C H A P T E R 12:
M s
r I Y
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 18 of 29
Contractionary Monetary Policy
Money, the Interest Rate, and Output:
M s
r I Y M d
Y decreases less than if r did not decrease
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 19 of 29
The Macroeconomic Policy Mix
Money, the Interest Rate, and Output:
( G or T) ( G or T)
Expansionary Y , r ?, I ?, C Y ?, r , I , C ?
( Ms)
MONETARY
POLICY Contractionary Y ?, r , I , C ? Y , r ?, I ?, C
C H A P T E R 12:
( Ms)
Key:
: Variable increases.
: Variable decreases.
?: Forces push the variable in different directions. Without additional
information, we cannot specify which way the variable moves.
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 20 of 29
Other Determinants of
Planned Investment
Money, the Interest Rate, and Output:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 21 of 29
Review Terms and Concepts
Money, the Interest Rate, and Output:
crowding-out effect
goods market
C H A P T E R 12:
money market
policy mix
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 22 of 29
Appendix: The IS-LM Diagram
Money, the Interest Rate, and Output:
graphically the
determination of
aggregate output
(income) and the interest
C H A P T E R 12:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 23 of 29
Appendix: The IS-LM Diagram
Money, the Interest Rate, and Output:
value of Y and r.
• Each point on the curve
represents equilibrium in
the goods market for a
C H A P T E R 12:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 24 of 29
Appendix: The IS-LM Diagram
Money, the Interest Rate, and Output:
value of Y and r.
• Each point on the curve
represents equilibrium in
the money market for a
C H A P T E R 12:
intersect corresponds
to the point at which
the goods market and
the money market are
in equilibrium.
C H A P T E R 12:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 26 of 29
Appendix: The IS-LM Diagram
Money, the Interest Rate, and Output:
• An increase in
government spending
Analysis and Policy
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 27 of 29
Appendix: The IS-LM Diagram
Money, the Interest Rate, and Output:
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 28 of 29
Appendix: The IS-LM Diagram
Money, the Interest Rate, and Output:
by an increase in
government spending leads
to an increase in aggregate
output, with no change in
the interest rate.
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 29 of 29