Macroeconomics

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Macroeconomics

IS-LM Basics

A) The IS curve slopes downward and to the right.

B) The LM curve slopes upward and to the right.

C) The slope of the LM curve depends on the interest sensitivity of money demand. An elastic money demand function caused the LM curve to be relatively flat. An inelastic money demand function caused the LM curve to be steep.

D) The slope of the IS curve depends on the slope of the investment function. If investment is highly interest elastic, then the IS curve is relatively flat. If investment is not highly interest elastic, then the IS curve is very steep.

E) The quantity of money and shifts in money demand at given levels of income and interest rates will shift the position of the LM curve.

F) Government expenditures, tax increases, and autonomous investment expenditures shift the position of the IS curve.

Transaction Demand – Money is a medium of exchange and individuals hold money for use in transactions. Money bridges the gap between the receipt of income and eventual expenditures.

Precautionary Demand – Keynes believed that, in addition to the money people held for planned transactions, more money was held for unexpected expenditures that were at times necessary. Money would be held for emergencies, to pay unexpected medical bills or repair bills of various types.

Speculative Demand – Money held by those speculating on future changes in the interest rate and the relationship the interest rate had with the level of bond prices.

Keynes’ Money Demand Function

Md = Co + (C1 x Y) + (C2 x R) , C1 * 0 , C2 * 0

A rise in income increases money demand, a rise in the interest rate leads to a fill in money demand.

Md = Money Demand

Y = Income

R = Interest Rate

C = Parameter (Holds no economic value)

Transaction Demand - Dependent positively on the level of income.

Precautionary Demand - Keynes believed that the amount of money held for this purpose depends positively on income. The interest rate might be a factor if people tended to economize on the amount of money held for the precautionary motive as interest rates rose.

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