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54 Cards in this Set

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What two economic forces/variables are always equal in the aggregate?
Income and Output
What are the three markets that the system is divided into?
Money Market, Goods Market and Financial Asset Market
How many markets have to be in equilibrium for the assumption to be made that all three are in equilibrium?
Two
What is the IS curve focused on?
Goods Market
What are the conditions for the goods market to be in equilibrium?
Investment spending = savings and total spending = total output
What relationship is established by the IS curve?
relationship between interest rates and income/output
IS curve (definition)
Represents all combinations of interest rates and income where the goods market is in equilibrium (where investment spending = savings, expenditures = production and supply = demand)
Which way does the IS curve slope?
down sloping from left to right (\)
Output = ? (equation)
Output = Consumer Spending + Investment Spending (Y=C+I)
(Re: IS curve) What is the relationship between interest rates and investments
Inverse
Steep IS curve
Not responsive to interest rate, highly sensitive to income
Shallow IS curve
Highly responsive to interest rate, not sensitive to income
What are on the axis of the IS curve
Vertical- Interest rates
Horizontal- Aggregate Output/Income (always the same)
LM Curve (definition)
The LM curve shows all combinations of the interest rates and income where the money market is in equilibrium
What is the LM curve focused on
Money Market
What is true when the money market is in equilibrium?
supply for money equals the demand for money.
Which direction does the LM curve slope?
Upward sloping from left to right (/).
What is fixed along the LM curve?
Supply of money.
(RE: LM curve) What is the relationship between Income and Interest rates?
Directly related
What does an increase in the money supply do to the LM curve?
Shifts the LM curve out
What does a decrease in the money supply do to the LM curve?
Shifts the LM curve in
How is the demand for money related to the interest rate? to income?
Inversely related to interest rate but directly related to income.
When is the LM curve the steepest?
When the demand for money tends to be relatively insensitive to interest rates.
Interest Rate is a function of what two things?
Demand for money and investment spending
When is the LM curve steep?
If the demand for money is very responsive to changes in income.
When is the LM curve shallow?
If the demand for money is highly sensitive to changes in interest rate
What does the intersection of the IS & LM curves represent?
They are both in equilibrium. It also shows equilibrium interest rate and equilibrium income/output.
What variables influence the demand for money?
Changes in income and interest rate
What variables are influenced by interest rates? and what is the relationship
Demand for money (inverse)and investment spending (direct)
What does the IS/LM model assume
The Interest rates are the only determinant of investment
What is the Equilibrium Interest Rate
Equilibrium interest rate is the interest rate at which the quantity of money demanded equals the quantity of money supplied. Increase in income and increase in demand for money is directly related. It causes equilibrium interest rate to increase.
How is inflation fixed in economy?
It uses fiscal policy by increasing taxes and/or a decrease in government spending.
When is Fiscal policy most effective?
Fiscal policy is most effective when the IS curve is steep and the LM curve is flat. Fiscal policy is highly effective in Liquidity Trap.
When is Fiscal policy least effective?
Fiscal policy is least effective when LM curve is steep or nearly vertical. Also, Fiscal policy is ineffective when crowding out takes place. When there is expansion in government spending, it raises interest rates
How does expansionary fiscal policy shift the IS curve?
Expansionary fiscal policy shifts the IS curve to the right
How does a contractionary fiscal policy shift the IS curve?
Contractionary fiscal policy shifts the IS curve to the left
When is fiscal policy highly effective and monetary policy ineffective?
IS curve is steep or nearly vertical
When is monetary policy is most effective?
Monetary policy is most effective when the IS curve is flat and LM curve is steep.
When is monetary policy is least effective?
Monetary policy is least effective when the LM curve is horizontal or flat; when the IS curve is steep or nearly vertical
What does expansionary monetary policy do to the LM curve?
Expansionary monetary policy that increases the money supply shifts the LM curve out (to the right).
What does contractionary monetary policy do to the LM curve?
Contractionary monetary policy (decreases in the money supply) shifts the LM curve in (to the left).
How will changes in the money supply affect the IS and LM curves?
An increase in money supply will cause the LM curve to shift down and a decrease to shift up. The IS curve is the opposite. Or increase in money supply shifts IS curve out and decrease shifts it back in.
What does the LM curve look like in Liquidity trap?
LM curve is flat.
What does the Liquidity trap do to interest rates?
Puts a floor under interest rates are regardless of changes in money supply interest rates will not drop beneath that level
What's the effectiveness of govt policies in Liquidity trap?
Fiscal policy is highly effective in a liquidity trap and monetary policy is least effective in a liquidity trap
When does liquidity trap occur?
When a floor is set and interest rates can’t go lower
What is the result of government cutting taxes and increasing government spending? (in terms of shifting curves)
IS curve shifts out (to the right).
How does the government shift the economy to Full employment equilibrium?
by shifting the IS curve out.
What is the result of government decreasing spending? (in terms of shifting curves)
The IS curve shifts in (to the left).
In the IS/LM framework, decreases in taxes and/or increases in government spending impact?
Shift the IS curve OUT and changes the equilibrium income
What factors might influence the effectiveness of economic policy and create problems using IS/LM curve to predict problems in the real world?
implementation and interpretation
What lags (delays) the influence or the effectiveness of policy changes?
Information lag
Implementation lag
Other problems with the effectiveness of policy change?
Uncertainty, Expectations: policy creates outcomes based on what people think is going to happen in the future. Full employment is not an exact point, there is no way to pinpoint exactly what our potential output really is.
Economic Policy of the 1980’s
Contradictory. Tight money, expansionary fiscal policy