IS-LM model

Question	Answer
• IS-LM model.	it’s macroeconomics tool which shows relationship between interest rates and total output, in the goods and services market and the money market. IS-LM schedules captures behaviours of good market and money market respectively.
• What IS stands for?	Investment saving.
• What LM stands for?	Liquidity preference-money supply.
• What is a fiscal policy?	Government expenditure and taxes.
• Expansionary fiscal policy?	Increasing government expenditure or decreasing taxes.
• Contractionary fiscal policy.	Decreasing government expenditure or increasing taxes.
• Expansionary monetary policy.	Increase in money supply by a central bank.
• CB.	Central bank.
• How central bank can increase money supply in an economy.	This can be done by injecting money in the market by buying bonds.
• IS-LM model.	It’s macroeconomics tool which shows relationship between interest rates and total output, in the goods+services market and the money market. IS-LM schedules captures behaviours of good market and money market respectively.
• What IS stands for?	Investment saving.
• What LM stands for?	Liquidity preference-money supply.
• Autarky.	Closed economy.
• IS-LM-BOP.	Mundell-Flemming model. It is an extension of IS-LM model.
• What’s the difference between IS-LM and Mundell-Flemming model?	The Mundell–Fleming model portrays the short-run relationship between an economy's nominal exchange rate, interest rate, and output (in contrast to the closed-economy IS-LM model, which focuses only on the relationship between the interest rate and output).
• What Mundell-Flemming model argues?	That an economy can’t simultaneously maintain fixed exchange rate, free capital movement and an independent monetary policy.
• Free capital movement.	No limits for foreign capital to go in and out a domestic economy. It effects equities, bonds and currency exchange trades.
• Capital reserve.	Money set aside for a purpose such as future investments or expenses.
• Perfect capital mobility.	No restrictions or cost to move capital from one country to another.
• Consumption is positive function of what? And negative function of what?	Consumption is positive function of income (Y) and negative function of interest rate.
• What r stands for?	Interest rate.
• What equation Y=C+G+I stands for?	Closed economy, therefore there’s no export and import.
• Why consumption is a negative function of interest rate.	Because if interest rate increases there is an opportunity cost to consume. Consumer might prefer save money if there’s higher interest rate instead of consuming.
• Equation expressing the negative and positive function of consumption.	C=C(Y,r)
• Equation expressing negative and positive function of investment.	I=I(r) Investment has negative function of interest rate.
• Capital goods.	Any tangible assets than an organization uses to produce goods or services such as machinery, equipment, buildings.
• What we can determine from IS curve?	Relationship between interest rate and income.
• IS curve downward or upward sloping?	It is downward sloping. Because if the interest rate increases income decreases. As downward sloping curve is narrow at the top and widens at the bottom which means the higher the y axis the smaller the relationship with x axis and vice versa.
• How increase of interest rate affect consumption and investment.	Consumption decreases, investment decreases.
• How decrease of interest rate effect consumption and investment.	Consumption increases (because not much incentive to save), investment increases (because it is cheaper to invest by taking a loan).
• How increase of interest rate effect Y?	It decreases because C and I decreases.
• How can issue of producing more than consuming can be fixed?	Interest rate can be decreased which stimulates consumption and investment. It can be decreased to the point where supply meets the need for consumption.
• What other factors than interest rate shifts IS curve?	a)Government expenditure (no matter what the interest rate is, if government spends more money GDP will increase). b)If taxes decrease. (more money, more spending). c)If capital stock decreases. (then it’s bigger payoff and therefore more interest in investment). d)Anticipated increase in future income. e)Expected increase in productivity level. (As productivity level increases therefore it generates the same profit by investing less, therefore incentives for investment increases.)
• What equation M=L means?	That money supplied by government is the same amount as money demanded by households.
• What M and L stands for in the equation M=L?	M – money supply. L – money demand.
• What increases and decreases demand for money?	Bigger income (Y) increases, bigger interest rate (r) – decreases (because with bigger rate there is incentive to save money, therefore there’s not so much money in circulation).
• Money demand equation.	L=L(Y,r) which means that money demand is affected by income (positively) and interest rate (negatively).
• LM curve is upward or downward sloping?	It is upward sloping.
• How to deal with an excess amount of money in the economy?	Decrease interest rate which stimulates spending. Spending increases money demand.
• How to deal with excess demand of money in the economy.	Increase interest rate which will disincentive investment and incentivize saving therefore reducing demand for money.
• If the money supply increases LM curve shifts to the right or left.	It shifts to the right.
• What intersection of IS-LM curves indicates?	Equilibrium between money and good markets.
• What can be done if IS-LM curve is out of the equilibrium (bigger consumption, investment than money supply)?	Interest rate can be increased which would put money and goods market back into equilibrium.
• Does increase of Y affect C?	Yes, C increases.
• Does increase in r affect C?	Yes C decreases?
• When fiscal policy might be more effective.	a)When money demand is more sensitive to the interest rate. b)Investment is not very sensitive to interest rate.
• What are effects of expansionary monetary policy?	CB injects money in economy by buying bonds – as demand for bonds grows bonds become more expensive and less risky – because it is less risky interest rate decreases.
• If LM curve shifts to the right how does it affect Y, C, r and I?	r decreases, C increases, I increases, Y increases.
• When monetary policy is more efficient.	When LM curve is steeper and IS curve is flatter. When investment is very sensitive to interest rate and money demand is not too sensitive to the interest rate.
• What is liquidity trap?	Interest rate is already close to zero, therefore injecting money in the economy and decreasing interest rate doesn’t help to boost the economy.
• Under liquidity trap is Lm curve steep or not?	It is flat.
• What differs Mundell-Flemming model from IS-LM model?	It adds balance of payments(trade with the world), therefore sometimes it is called IS-LM-BOP.
• How many curves has Mundell-Flemming model and which?	IS – goods market curve. LM – money supply curve. BOP – international trade curve.
• Equation for savings.	S=Sa+sY Total savings consists of autonomous savings (Sa) and marginal propensity to save (sY).
• Equation for import.	M=Ma+mY Ma – autonomous imports. mY – marginal propensity to import.
• What is called leakage in Mundell-Flemming model?	S+M. The fact that all increase in the income doesn’t contribute to the economy, some income goes to savings and import and the rest goes towards consumption and investment.
• Under what factors IS curve shifts to the right in Mundell-Flemming model?	If G,I, X increase or S, M decrease. Also e (exchange rate) depreciation, because that would lower imports and increase exports.
• Equation of balance of payments.	BP=CA(Y,r)+KA(r-r) r - domestic interest rate. r - foreign interest rate.
• In IS-LM model investment has inverse or positive function to interest rate?	Inverse.
• In Mundell-Flemming model CA has inverse and positive function to what.	Inverse function to Y and positive function to e.
• Why CA has inverse function to Y?	Because as Y increases M increases and therefore CA decreases.
• What can offset CA deficit?	KA surplus.
• BP curve is upward or downward sloping?	It is upward sloping because. Higher Y creates deficit in CA and in order to balance it with capital inflow interest rate needs to increase. Because the higher the interest rate, the more investors it attracts therefore more capital inflow.
• When BP curve shifts to the right.	When exports increase or imports decrease.
• What effects expansionary monetary policy has?	r goes down, I goes up therefore Y goes up. Then imports increase, that makes exchange rate to depreciate. Depreciation of e improves the CA which moved to deficit after initial income increase.
• How expansionary fiscal policy is financed?	• How expansionary fiscal policy is financed?

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	Created by midasremin almost 10 years ago