2. A Presentation By : -
 Dhananjay Ghei
09HS2023
 Abhishek Jadon
09HS2010

3. The Goods and The Money Market
Equilibrium
 Equilibrium of the goods market is achieved when the
goods market is cleared, i.e. , according to Keynes,
planned saving is equal to planned investment.
S=I
OR
Y=C+I
 Equilibrium of the money market requires equality
between the supply of and the demand for money.
Ms = Md

4. Equilibrium in the Goods Market
 In developing the IS model, investment is
considered as a function of rate of interest ,
consumption and saving as functions of income.
Investment Function : I = I(r)
Consumption Function : C = C(Y)
Saving Function : S = S(Y)
 Equilibrium in the goods market is achieved when
:-
S(Y) = I(r)
 However, this relationship may be shown
graphically as follows

5. IS Curve
 Re-translation of Simple Keynesian model at
equilibrium (Investment = Saving).
 A plot of equilibrium output for various
interest rates within the market for goods and
services.

6. Determining Output
 Note two characteristics of ZZ:
Because it’s assumed that the
consumption and investment
Relations are linear, ZZ is,
in general, a curve
rather than a line.
ZZ is drawn flatter than a 45-
degree line because it’s
assumed that an increase in
output leads to a less than one
for-one increase in demand.

7. Deriving the IS Curve
 Deriving the IS Curve
(a) An increase in the interest rate
decreases the demand for goods
at any level of output, leading to
a decrease in the equilibrium level of
output.
(b) Equilibrium in the goods market
implies that an increase in the
interest rate leads to a decrease in
output.

8. Properties of IS Curve
 Downward Sloping,
i  C, I  Y*
 Increase/Decrease in autonomous
expenditure will shift the IS curve
Rightward/Leftward.
 The steepness or flatness of the IS curve
describes the elasticity or responsiveness of
C and I to the nominal interest rate.
-- Steep IS curve: inelastic.
-- Flat IS curve: elastic.

9. Shifts in IS Curve due to taxes
 An increase in taxes
shifts the IS curve to
the left.

10. Equilibrium in the Money Market
 Money Market Equilibrium is achieved when the
supply of money and demand for money are
equal.
M s = Md
 Money Demand is made of two parts : -
Msp : Speculative Demand for Money
Mt : Transactionary Demand for Money
Md = Msp + Mt

11. LM Curve
 Depicts equilibrium in the Money market (L =
M), as well as the Bond Market (by Walras
Law).
 A plot of the equilibrium interest rate for
various levels of output or income, within the
money market for a given level of the nominal
money supply.

12. Deriving the LM Curve
 An increase in income rate.
leads, at a given  Equilibrium in the
interest rate, to an financial markets
increase in the implies that an
demand for money. increase in income
Given the money leads to an increase in
supply, this increase the interest rate. The
in the demand for LM curve is therefore
money leads to an upward sloping.
increase in the
equilibrium interest

13. Deriving the LM Curve

14. Properties of LM Curve
 Upward sloping,
Y  L  i*
 Increase/Decrease in the real money supply
shift the LM curve Rightward/Leftward.
 The steepness or flatness of the LM curve
describes the elasticity or responsiveness of
money demand (L) to the nominal interest
rate.
-- Steep LM curve: inelastic.
-- Flat LM curve: elastic.

15. Shifts in LM Curve due to change in
Money Supply
 An increase in money
causes the LM curve
to shift down.

16. Two – Market Equilibrium
 The intersection point of the IS and LM curve
denotes the equilibrium point between the two
markets.
 There is only one combination of Y and r at which
both the goods market and the money market are
in equilibrium simultaneously.

17. The Equilibrium Curve

18. Fiscal and Monetary policies
 Fiscal contraction, refers to fiscal policy that reduces the
budget deficit.
 An increase in the deficit is called a fiscal expansion.
 Taxes affect the IS curve, not the LM curve.
 Monetary contraction, refers to a decrease in the
money supply.
 An increase in the money supply is called monetary
expansion.
 Monetary policy does not affect the IS curve, only the
LM curve.
 For example, an increase in the money supply shifts
the LM curve down.

20. Effects of Fiscal and Monetary
Policy

21. Quiz
 In the IS side of the IS-LM model, the money market:
a.) is implicit in the I curve
b.)is completely absent
c.) conditions equilibrium
 The goods market side of the IS-LM model is:
a.)flow model
b.)stock model
c.) neither
 If I is highly sensitive to r then, graphically:
a.) IS curve will be close to vertical
b.) IS Curve will be close to horizontal
c.) IS Curve will be impossible to draw

22. Quiz
 Equilibrium in the Goods Market occurs when:
a.) I + G = S + T
b.) G = T
c.) S = T
 Graphically, a fall in G would:
a.) shift IS rightward
b.) shift IS leftward
c.) make IS vertical
 The money market side of the IS-LM model is:
a.) flow model
b.) stock model
c.)neither

23. Quiz
 Speculative demand for money is a function of:
a.) r
b.) Y
c.) G
 In IS-LM model, money supply is:
a.) endogenous
b.)exogenous
c.)irrelevant
 Since the velocity of money increases as interest rates rise
the:
a.) LM curve is positively sloped
b.)LM curve is negatively sloped
c.)IS curve is negatively sloped

24. Quiz
 A change in the public's desire to hold money will:
a.) shift the LM curve
b.) change the slope and position of LM Curve
c.) change the slope of LM Curve
 When the central bank sells government bonds on
the open market we have:
a.) contractionary monetary policy
b.) expansionary monetary policy
c.) contractionary fiscal policy
d.) expansionary fiscal policy

25. Quiz
 If the Congress passes wage and price controls in response
to increased inflation we have had:
a.) contractionary monetary policy
b.) expansionary monetary policy
c.) contractionary fiscal policy
d.) expansionary fiscal policy
e.) none of the above
 The IS curve shows all combinations of income and:
a.) interest rate for which the goods market is in equilibrium
b.) interest rate for which the money market is in equilibrium
c.)price level for which the goods market is in equilibrium
d.)price level for which the money market is in equilibrium

26. Quiz
 In terms of the ISLM model, an increase in tax rates
should move the:
a.)IS curve left
b.)IS curve right
c.)LM curve right
d.)LM curve left
 The LM curve depicts Y,r combinations at which:
a.) transactions and speculative demands are equal
b.)transaction demand does not exceed speculative
demand
c.)money demand equals money supply

29. What happened in U.S. in 2001?
 The U.S. economy shrank in three quarters in the early
2000s (the 3rd quarter of 2000), the first quarter of
2001, and the third quarter of 2001.
 The US economy was in recession from March 2001 to
November 2001, a period of eight months.
 2.1 million people lost their jobs as unemployment rose
from 3.9% to 5.8% .
 GDP growth slowed to 0.8% ( compared to 3.9%
annual average growth during 1994-2000)

30. Causes of U.S Recession
 Stock Market Decline
1500 Standard & Poor’s 500
1200
Index
900
600
300
1995 1996 1997 1998 1999 2000 2001 2002 2003
 9/11 Attack on U.S.

31. Outcome of the Recession
 Increased Uncertainty.
 Fall in Consumer and Business Confidence.
This all resulted in : -
 Lower Spending, IS curve shifted towards
left.
 Reduced Stock Prices, Discouraged
Investment

32. Measures taken
 Fiscal Measure
IS Curve shifts towards Right
1. Tax cuts in 2001 and 2003
2. Spending Increases
a. Airline industry bailout
b. Afghanistan War
 Monetary Measure
LM Curve shifts donwards towards Right.
1. Rise in interest rate
2. Depress Income

33. The U.S Recession with IS – LM
Model
 The decrease in investment
demand led to a sharp shift
of the IS curve to the
left, from IS to IS”.
 The increase in the money
supply led to a downward
shift of the LM curve, from
LM to LM’.
 The decrease in tax rates
and the increase in spending
both led to a shift of the IS
curve to the right, from IS’’ to
IS’.

34. Conclusion
 IS Curve represents the equilibrium of the goods
market.
 LM Curve represents the equilibrium of the money
market.
 The point of intersection of the two curves is the point
of equilibrium of both the markets simultaneously.
 By taking both fiscal and monetary measures using
the IS – LM model recession can be checked out.

35. Refrences
 Books referred : -
1. Macroeconomic Analysis : - E. Shapiro
2. Macroeconomics : – N. Gregory Mankiw
3. An Inquiry into the Nature and Causes of the
Wealth of Nations : - Adam Smith
 Online References : -
1. Wikipedia
2. Authorstream
3. IS – LM model by Dudley Cooke (Trinity College
Dublin)

36. Thank You