AD in the closed Economy Flashcards
(24 cards)
What does IS summarise
The Product market
What does LM summarise
The money market
How does the slope of the AS curve affect the impact of monetary/fiscal policy
- If AS is vertical, only affects prices
- If AS is horizontal, only affects output
What did people of 50s/60s/70s assume about AS
That it was horizontal
What did peole after 70s think about AS
Considered it as vertical at least in the long run
What are the two behavioural relations in the product market
- Consumption/savings behaviour
- Investment behaviour
How will actual expenditure differ from planned expenditure
If there are unplanned increases or decreases in inventories
Explain the product market equilibrium requirement
- Unplanned inventories must be zero
- If unplanned investment is positive then firms will reduce production
- if inventories are lower than intended, firms will increase production
What needs to be equal to each other for equilbirum in the product market
Injections= withdrawals
What happens if planned injections are less than withdrawals
- Inventories are higher than intended and this will trigger a decrease in production
What happens if planned injections are higher than withdrawals
Inventories are lower than intended and this will trigger an increase in production
What is the relationship between consumption and disposable income
As incomes rises so does consumption
As disposable income rises what happens to savings
They also rise
What is the final behavioural assumption underlying the product market regarding investment
Investment depends on the interest rate
What is assumed about government spending for the IS curve
It is a fixed vertical dashed line which isn’t impacted by the IR
What is the relationship between investment and interest rates
As interest rates rise, investment falls
What does the IS curve show overall
The combinations of Rt and Yt for which there is equilibrium in the product market
Summarise the formation of the IS curve
- Bottom right- As Income/output rises, savings rise
- Bottom left- Equilibrium condition, Injections= Withdrawals
- Top left- as interest rates rise, investment falls
- Top right- downward sloping in Rt Yt space
How does an increase in gov spending impact the IS curve
It shifts it to the right
Explain the role of inventories when the product market is out of equilibrium
- An increase in government spending causes outward shift
- Initially, original equilibrium is to the left of the IS curve at existing IR and output level
- Planned injections are greater than withdrawals so unplanned injections must be negative with inventories run down more than hoped
- So, this triggers an increase in production, shifting the IR/ output combo until equilibrium is reestablished
What is the LM summarise by
The idea that money is demanded for transactions and to store wealth
Summarise the derivation of the LM curve
- Bottom right, as Y increases money for transaction purposes increase
- Bottom left, Shows equilibrium condition thta total demand for money= total supply
- Top low interest rates mean people hold money instead of bonds as expect IR and thus bond prices to fall
Explain the role of bonds when the money market is out of equilibrium
- If money supply increases, initial equilibrium is left of LM curve at existing IR and output level, the demand for transactions +speculative are less than the money supply
- This is equivalent to excess demand for bonds thus interest rates fall and cause shift downwards of LM curve
Explain how AD is formed
At the point of equilibrium between IS and LM
