Please enable JavaScript.
Coggle requires JavaScript to display documents.
Topic 7: LS-LM/ AD- AS Model (From IS-LM to AD- AS (Aggregate demand (AD)…
Topic 7: LS-LM/ AD- AS Model
The FE (full- employment) line
Factors that change the FE line
Increase in labor supply (shift the FE line to the right)
Increase in the capital stock:
more outputs
will be produced with the same amount of labor => increase
MPN
=>
labor demand increases
=> FE shift to the right
Beneficial supply shock
:
more outputs
can be produced with the
same amount of capital and labor
=> MPN rises => labor demand increases => FE shifts to the right
The IS curve
Factors that change the IS curve
Government purchases: up and to the right as savings falls
Taxes: no change (if
Ricardian equivalent hold
), if it is not hold => increases in tax will reduce consumption => savings rises => IS curve will shift down and to the left
Wealth: up and to the right (desired savings falls)
Expected future product of capital (MPK): up and to the right as desired investment increases
Expected future output
: IS shifts up and to the right because
desired savings falls
Effective tax rate on capital: down and to the left as
desired investment falls
LM (Liquidity Money/ Market) curve
Factors that shift the LM curve
Nominal money supply (MS) increases: down and to the right because MS increase => r decrease (
to equate money supply and demand
)
Price level (P) increases: up and to the left because
increase in P
=> MS falls => r rises to clear the assets market
Increases in expected inflation: down and to the right because MD falls => lowering the real interest rate
Nominal interest rate on money: up and to the left because MD increases => raising the interest rate
Long- run equilibrium
Applying IS - LM Framework
Temporary adverse supply shock
productivity falls
due to some disease => lower MPN => output- labor curve shifts down => demand curve for labor also shifts down => employment falls => FE line shifts to the left => supply < demand => price level increases => MS curve shifts to the left => LM curve shifts to the left in order to bring all markets into equilibrium
effect
FE line shifts to the left => Y falls
No effect on the LM and IS curves in the short run
to attain equilibrium, price must adjust =>
inflation rises
temporarily but not permanently
During the whole process, IS curve does not move
higher interest rate => consumption falls (saving rises) and investment falls (
is that considered that it is effect the IS curve?
)
From IS-LM to AD- AS
IS- LM related r to Y
AD- AS related P to Y
Aggregate demand (AD) curve
shows the relationship between the quantity of goods demanded and the price level when the
goods market and assets market are in equilibrium
AD curve
represents the price and output
level at which the IS and LM curve intersects
AD curve: downward sloping
P increases => reduces money supply => increase the real interest rate =>
LM curve shifts up
as interest rate increases =>
consumption and investment decreases
=> lower quantity of output demanded
Factors that shift the AD curve
IS curve shifts to the right => AD curve will also shift to the right
(example: increase in G)
LM curve shifts to the right => AD curve will shift to the right (
why is that because one is upward sloping and one is downward sloping?
)
AS curve
shows the relationship between the price level and the aggregate quantity of output that firms supply
in the short run:
fixed price
=> firms will supply whatever output is demanded (
horizontal line
)
in the long run: firms supply at
full employment output
level at any price level (
vertical line
)
factors that shift SRAS
increases the cost of production => increases in price
factors that lead to reduce in price
factors that shift LRAS
FE line
shifts to the right =>
LRAS
also shifts to the right and vice versa
AD- AS equilibrium
The effect of
expansionary monetary policy
MS increases => LM curve shifts to the right => markets are out of equilibrium => r falls => consumption and investment increases temporarily => Y increases (
in the short run only
)
In the long- run
: supply < demand => price level increases => MS will decrease =>
LM curve shifts to the left and up until LM curve intersect with IS curve and FE line in the equilibrium
Money neutrality
if a
nominal
money supply changes the
price level proportionately
but has
NO EFFECT on the real variables
all real variables (including real wage) do not change
nominal values
(including the nominal wage) have
risen proportionately with money supply
Price adjustment
Classical Model
Keynesian model