Chapter 2. Deriving the IS and LM Curves

2.1 Section Title

Macro Models
Quiz
30
You must complete the entire activity before you can take the quiz.

Deriving the IS and LM Curves

Question Deriving the IS and LM Curves

AuQtbHFRAgeZVYoa9Op8EAWfnN0Ik0LVqup68cO4ebB8i3CvKO+6WssNS+i+EINL+4QxESgQw1isdQ35qMcWiWS8VPlg7RWrnr2IIGXIabJJmYG4C81MB/OCHvgOBOCJ4cfaKeLdCqksCc1IuRGtriCWmRb55NHtAqt7ucbnTNIRxPa4A9kEP/Tpx8gZJxA+sxTTX6DQi729dJcqLe0xviu3GbFfwO37T73ha8paZB2NpicwYSr7JTxRvLWO7gyDnkFoLQq6KIhEWaNmERPMkrzL7IRkA3Ri+HvlQmFnJi8giLQKXhefve/gP9nnM55b
An increase in the interest rate will reduce investment spending because it is more expensive to borrow. Therefore planned expenditure E = C + I + G will fall. The decline in planned expenditure will cause firms to reduce output as inventories increase.

Question Deriving the IS and LM Curves

RXLSO4EKTyo0NFg0ezKssEsY5+KHUFQx3RMBwDf6WgcOE1Etmviyc4xC7SAriq1rRhR8KwYSwNM/O5MmTre/yVAhj0o6WeWh3f11sIUb61LGj8LQiWrAk0syrmx6vYKZ3hLKNulAmcSSxhUtQrQRtMTVc+tih1TqaeK8m3nf3oNwERx/KQgIdP9ihIPUPszKr43MuGrDRBk/Y2KFU8FDkqFvRenoT/pA7WVAcPtMOM9XpGDsOLVkz1TCV4au1nzqpAWo9or28pwT5UEDmjPr/QQqi3xpc9kc89iWUByvWAbQAist1AFQFexyxYr0LPc/WBNE6Q==
An increase in government spending will increase planned aggregate expenditure as given by E = C + I + G. This shifts the planned aggregate expenditure schedule upwards, leading to an increase in equilibrium output for any given level of the interest rate. This increase in equilibrium output will shift the IS curve to the right.

Question Deriving the IS and LM Curves

lHdiv7fwsT6dY12hcGs82NsX62Z6AfNtIIEipl5eMSLh3w+vHpO1gZ4TQ9nk1uIDRuJuWkd9loALT7TjMCwbAVueolGCp33gVzc8l7SWduuR0u7TNk4lbYUM9TQhWqIyUnTH0SNIK7wsy8rlrdtmM1aKCGA6ib3o+J5R7owbGEKVlDp4i03+VfG6F/3jgUlXK2THVDg2xMYeltLqMWomcdLyrh7RO5PmiPEoA+K3WXT3aUOvh3MQ1uR8yzccE+LgUWaQDAaW+heurszcK1CuC0vwaocxxNAu1PRWqjA6W78BMN7HzLdI+9sUE8Uy3eY2KXnHJ6C/HFXcB5ES
An increase in income will increase consumption spending, and this will give people an incentive to hold and therefore demand more money. This shifts the money demand curve to the right, leading to an increase in the interest rate. When money demand increases relative to money supply, people sell bonds in an attempt to hold more money. This pushes bond prices down and causes the interest rate to rise.

Question Deriving the IS and LM Curves

in8fa7jZhknLFzaV0Z6OLivWoYlSyc7kbXxZs4P7R67Y+jyNZi7vtFQMm3jetVVEVSiMy87zWX8F0sznIX8asCKD//Cocl7y9LxytRBzD1tHOZtDRvUs99sY2TcewfUbNjdm5gj4iLlW3WjdwCM3dP0Zk38MRsMbykJp2JdULpner4YPjc5bq9lSRTSoHkVvNLICyrIuxff4+WOHF6Ixq4IREdvmGEImbbmG0G9OBqvCY+CO2/rTRu5dO3s9mC1wsAR1qQ==
An increase in the money supply will cause the quantity of money balances supplied to exceed the quantity of money balances demanded. As people attempt to convert money to bonds (interest-bearing assets) this will increase the demand for bonds, and hence the price of bonds. The increase in the price of bonds will reduce the interest rate. When the interest rate falls for any given level of income (Y) this will shift the LM curve down and to the right.