IS-LM Model

Overview

IS Curve: Goods Market
LM Curve: Money Market
FE Line: Labor Market

IS Curve

Relationship between $r$ and $Y$ in equilibrium of goods market

downwards sloping all points must satisfy: $Y=C^d+I^d+G$

Recall Goods Market Equilibrium, where the equilibrium condition:

$S^d=I^d$ also Factor Analysis

Thus:

if $I^d\uparrow$ (shifts right) then $r\uparrow ⟹$ IS curve shifts right

if $S^d\uparrow$ (shifts right) then $r\downarrow ⟹$ IS curve shifts left

LM Curve

relationship between $r$ and $Y$ in Money Market

all points at Money Market eq: $\frac{M^d}{P}=\frac{M^s}{P}$

Money Supply and Money Demand are in real terms

if $M^d\to$ then LM $\leftarrow$, $r\uparrow$

if $M^s\to$ then LM $\to$, $r\downarrow$

FE Line

relationship between $r$ and $Y$ in the Labor Market

must satisfy $\bar{Y}=AF(K,\bar{N})$

FE line only in long run because: $\bar{N}$ determined by wages and prices (real wage), and in SR prices are fixed

• real interest rate ($r$) has no effect on labor market

General Equilibrium

If $\bar{Y}>Y⟹P\downarrow ⟹$LM shifts right

If $\bar{Y}<Y⟹P\uparrow ⟹$LM shifts left

where Y is given by IS $\cap$ LM