LECTURE OUTLINE

• Goods markets and IS curve

– Derivation
– Shifts
 Deriving the IS curve:
From Y = C + I + G to S = I
Figure 9.3 Effect on the IS curve of a temporary
increase in government purchases
 Shifting the IS curve: G
E E =Y E =C +I (r )+G
At any value of r, 1 2

G  E  Y E =C +I (r1 )+G1
…so the IS
curve shifts to
the right. Y1 Y2 Y
r
The horizontal r1
distance of the
Y
IS1 IS2
IS shift equals
1 Y
Y  G Y1 Y2
1 MPC
 Solving for Y
Y  C  I  G equilibrium condition

Y  C  I  G in changes

 C  G because I exogenous

 MPC  Y  G because C = MPC Y

Collect terms with Y Solve for Y :

on the left side of the
equals sign:  1 
Y     G
(1  MPC)  Y  G  1  MPC 
 An increase in taxes
E Y

=
Initially, the tax E E =C1 +I +G
increase reduces
consumption, and E =C2 +I +G
therefore E:

C = MPC T At Y1, there is now

an unplanned
…so firms inventory buildup…
reduce output,
and income falls Y
toward a new E2 = Y 2 Y E1 = Y 1
equilibrium
 An increase in taxes
Figure 5 - 4
Shifts of the IS
Curve

•An increase in
taxes shifts the IS
curve to the left.
 Solving for Y
eq’m condition in
Y  C  I  G
changes
 C I and G exogenous

 MPC   Y  T 
Solving for Y : (1  MPC)  Y   MPC  T

  MPC 
Final result: Y     T
 1  MPC 
 Shifts of the IS Curve
•Let’s summarize:
 Equilibrium in the goods market implies that
an increase in the interest rate leads to a
decrease in output.
 Changes in factors that decrease the
demand for goods, given the interest rate
shift the IS curve to the left.