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Part 4

Chapter 12
Money, Interest and Income

Slide 1

Copyright 2002 McGraw-Hill Ryerson Limited

THE SHORT RUN RELATION OF MONEY, THE


INTEREST RATE, AND OUTPUT, 19692000

Figure 12-1
In the short run, when the real money stock decreases, for instance, in
the early 1980s, the interest rate goes up and real output goes down.

Slide 2

Copyright 2002 McGraw-Hill Ryerson

THE STRUCTURE OF THE IS-IM MODEL

Figure 12-2
The IS-LM model emphasizes the interaction between the goods and
assets markets. Spending, interest rates, and income are determined
jointly by equilibrium in the goods and assets markets.

Slide 3

Copyright 2002 McGraw-Hill Ryerson

THE INVESTMENT SCHEDULE


Figure 12-3
The investment schedule
shows the planned level
of investment spending
at each rate of interest.

Slide 4

Copyright 2002 McGraw-Hill Ryerson

DERIVATION OF THE IS CURVE


Figure 12-4(a)
At a particular interest
rate, equilibrium in panel
(a) determines the
income level. A decrease
in the interest rate raises
aggregate demand. The
IS curve shows the
resulting negative
relationship between
interest rates and
income.

Slide 5

Copyright 2002 McGraw-Hill Ryerson

DERIVATION OF THE IS CURVE (contd.)


Figure 12-4(b)
(contd.)
At a particular interest
rate, equilibrium in panel
(a) determines the income
level. A decrease in the
interest rate raises
aggregate demand. The IS
curve shows the resulting
negative relationship
between interest rates
and income.

Slide 6

Copyright 2002 McGraw-Hill Ryerson

EFFECT OF THE MULTIPLIER ON THE SLOPE


OF THE IS CURVE
Figure 12-5(a)
A higher marginal
propensity to spend
results in a steeper
aggregate demand curve
and, consequently, a
flatter IS curve.

Slide 7

Copyright 2002 McGraw-Hill Ryerson

EFFECT OF THE MULTIPLIER ON THE SLOPE


OF THE IS CURVE (contd.)
Figure 12-5(b)
(contd.)
A higher marginal
propensity to spend
results in a steeper
aggregate demand curve
and, consequently, a
flatter IS curve.

Slide 8

Copyright 2002 McGraw-Hill Ryerson

A SHIFT IN THE IS CURVE CAUSED BY A


CHANGE IN AUTONOMOUS SPENDING
Figure 12-6(a)
An increase in
autonomous spending
increases aggregate
demand and increases
the income level at a
given interest rate. This
is represented by a
rightward shift of the IS
curve.

Slide 9

Copyright 2002 McGraw-Hill Ryerson

A SHIFT IN THE IS CURVE CAUSED BY A


CHANGE IN AUTONOMOUS SPENDING (contd.)
Figure 12-6(b)
(contd.)
An increase in
autonomous spending
increases aggregate
demand and increases
the income level at a
given interest rate. This
is represented by a
rightward shift of the IS
curve.

Slide 10

Copyright 2002 McGraw-Hill Ryerson

DEMAND FOR REAL BALANCES AS A


FUNCTION OF THE INTEREST RATE AND
REAL INCOME
Figure 12-7
The higher the rate of
interest, the lower the
quantity of real balances
demanded, given the
level of income. An
increase in income raises
the demand for money,
as shown by the
rightward shift in the
money demand schedule.

Slide 11

Copyright 2002 McGraw-Hill Ryerson

DERIVATION OF THE LM CURVE


Figure 12-8(a)
Panel (b) shows the
money market. The
supply of real balances is
the vertical line M/P. L1
and L2 represent money
demand at different
levels of income (Y1 and
Y2).

Slide 12

Copyright 2002 McGraw-Hill Ryerson

DERIVATION OF THE LM CURVE (contd.)


Figure 12-8(b)
Panel (b) shows the
money market. The
supply of real balances is
the vertical line M/P. L1
and L2 represent money
demand at different
levels of income (Y1 and
Y2).

Slide 13

Copyright 2002 McGraw-Hill Ryerson

AN INCREASE IN THE MONEY SUPPLY


Figure 12-9(a)
When the real money
supply increases, the
money market is no longer
in equilibrium. In order to
restore equilibrium, for a
given level of income, the
interest rate must
decrease. Therefore, the
LM curve shifts outward
for an increase in the real
money supply.

Slide 14

Copyright 2002 McGraw-Hill Ryerson

AN INCREASE IN THE MONEY SUPPLY (contd.)


Figure 12-9(b)
When the real money
supply increases, the
money market is no longer
in equilibrium. In order to
restore equilibrium, for a
given level of income, the
interest rate must
decrease. Therefore, the
LM curve shifts outward
for an increase in the real
money supply.

Slide 15

Copyright 2002 McGraw-Hill Ryerson

GOODS AND MONEY MARKET EQUILIBRIUM


Figure 12-10
At point E, interest rates
and income levels are
such that the public
holds the existing money
stock and planned
spending equals output.

Slide 16

Copyright 2002 McGraw-Hill Ryerson

AN INCREASE IN AUTONOMOUS SPENDING


SHIFTS THE IS CURVE TO THE RIGHT
Figure 12-11
The equilibrium interest
rate and level of income
both rise.

Slide 17

Copyright 2002 McGraw-Hill Ryerson

DERIVATION OF THE AGGREGATE


DEMAND SCHEDULE
Figure 12-12(a)
For a given nominal money
stock, a price level decrease
increases the real money
stock. This shifts the LM
curve outward, and the
interest rate goes down and
income increases. Therefore,
along the AD curve, a price
level decrease (holding the
nominal money stock
constant) is consistent with
an income increase, and the
AD curve slopes downward.

Slide 18

Copyright 2002 McGraw-Hill Ryerson

DERIVATION OF THE AGGREGATE


DEMAND SCHEDULE (contd.)
Figure 12-12(b)
(contd.)
For a given nominal money
stock, a price level decrease
increases the real money
stock. This shifts the LM
curve outward, and the
interest rate goes down and
income increases. Therefore,
along the AD curve, a price
level decrease (holding the
nominal money stock
constant) is consistent with
an income increase, and the
AD curve slopes downward.

Slide 19

Copyright 2002 McGraw-Hill Ryerson

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