STUDY UNIT 4 Flashcards
What relationship does investment spending have with the level of output and the interest rate? show the chain of events too
investment spending has a positive relationship with the level of output and a negative relationship with interest rates.
I= I(Y,i )
+ -
why is there a positive relationship with investment spending and the level output? show the chain of events too
an increase in the level of production implies an increase in the level of sales.
Y increase -> I increase (and visa versa)
what is the aim of investment?
the aim of investment (building a new factory) is to make a profit.
why does investment spending and interest rates have a negative relationship with each other?
the higher the interest rate, the higher the cost of borrowing, the higher the opportunity cost of own funds, the less attractive it is borrow money and the lower the level of investment spending will be.
what is the new demand equation for the equilibrium output and income?
Y= [c0+c(Y-T) +I(Y, i) +G
What market is the IS curve derived at?
the goods market
What market is the IM curve derived at?
the financial market
what types of curves does the IS and IM curves have?
the IS curve is curvy and the IM curve is horizontal
what are the equations for the IS and IM curves?
IS: [c0+c(Y-T) +I(Y, i) +G
IM: M/P (quantity of money)= YL(i)
what is the most important variable in the IS-IM model
the level of output and income (Y)
which variable has an effect on the endogenous (dependent) variable?
an exogenous (indepenent) variable has an effect on the endogenous variable but is not influenced by the endogenous variable.
list the endogenous variables of the IS-IM model
- the YD of the consumption function
- interest rates (i) and some parts of investment
- the money demand (Md) has 2 endogenous variables. firstly, the money demand is negatively related to the interest rates and secondly, the money demanded is positively related to the level of output and income (Y)
- the quantity of money is determined by the demand for money which is partly determined by the interest rate (i) and the level of output and income
list all of the exogenous variables in the IS-IM model
- the autonomous or exogenous variables in the consumption function are c0 and c (marginal propensity to consume)
- part of investment (I) that is influenced by expectations, business confidence and political and social factors
- government spending
- taxation
- interest rates
what happens to the IS curve when there’s an increase in government spending?
it causes the IS curve to shift rightwards
what happens to IM curve when there is a decrease in interest rates?
it causes the IM curve to to shift downwards.
what is a fiscal expansion?
it is the demand for goods an expansionary policy is used to stimulate economic activity by increasing (aggregate demand)
what is a fiscal contraction?
a contractionary policy used to “cool down” economic activity by decreasing the demand for goods (aggregate demand).
explain what causes the IS curve to shift to the left in the goods market? show the chain of events as well
an increase in taxation because at each and every interest rate, the demand for goods and the equilibrium level of output are lower and a leftward shift of the IS curve occurs
T increases-> Yd decrease-> C decreases-> Z decreases-> Y decreases
this causes a decrease in the level of output and income, which also leads to a decrease in investment spending
Y decreases-> I decreases
explain what causes the IM curve to move along in the financial market? show the chain of events as well
the interest rate remains unchanged
i=i
the decrease in the level of output an income causes a decrease in demand for money and the quantity if money
Y decreases-> Md dereases-> M decreases
what is contractionary monetary policy ?
it is when the central bank increases the interest rates in order to dampen the economic activity by reducing the demand for goods.
what is expansionary monetary policy?
it when the central bank decreases the interest rate in order to stimulate the economic activity by increasing the demand for goods
what movement does the IS-IM curves have when there is a decrease in interest rates?
the LM curve shifts downwards and the IS curve doesn’t shift
what’s the impact does a decrease in the interest rates have on the financial market?
there is an expansionary monetary policy.
monetary expansion= i decreases
a decrease in the interest rate results in an increase in the demand for money and the quantity of money
income increase demand for money and the quantity of money
Y increases-> Md increases-> M increases
what’s the impact does a decrease in the interest rates have on the goods market?
the economy moves along the IS curve. the decline in interest rates increases investment spending and the demand for goods increase. this leads to an increase in the multiplier an everything is good
i decreases-> I increases-> Z increase-> Y increase
