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ISLM Video Tutorial - YouTube
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ÿÿÿÿ ÿÿÿÿ ÿÿÿÿ " " " " " " " " " P
} Í : " " " ~ This video covers the finding
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simultaneous equilibrium in the goods market
and the money market by combining the IS and
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LM curves. This leads to a method for deriving
the Aggregate Demand curve. This model is
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also used to anticipate the economy's response
to fiscal and monetary policy.
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This slide displays the goods and services
market on the top right hand side. The money
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market is on the left.
First, in the goods market, the horizontal
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line is the equilibrium condition and the
aggregate demand equation extends upward.
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The equilibrium interest rate and level of
income are extended down to derive the IS
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curve. The higher interest rate results in
a higher equilibrium income. Connecting these
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points creates the IS Curve.
In the money market, on the left, the real
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money supply is the grey vertical line. When
the demand for money curve crosses it the
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equilibrium interest rate is found. For a
higher level of national income (Y2), the
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equilibrium interest rate is higher; these
points create the LM curve.
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The intersection of the IS and LM curves denotes
the equilibrium level of interest and income
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that will have both markets in simultaneous
equilibrium.
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From this information we can derive the aggregate
demand curve in the Price/Income graph on
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the top right. This is done by finding the
IS-LM equilibrium for different price levels.
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Price levels are in the real money supply
equation that is represented by the grey vertical
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bar. By drawing LM curves for different price
levels, we can produce enough points in the
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P/Y space to derive the aggregate demand curve.
The LM curve is drawn for the first price
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level, producing the first point at the intersection
of P1 and the resulting equilibrium level
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of national income.
A reduction the price level increases the
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real money supply because people can buy more
with the money they have. The lower price
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level shifts the money supply line outward.
This causes the LM curve to shift down and
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the equilibrium income (Y2) to be further
to the right. Where this line intersects with
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P2, the second point of the Aggregate demand
curve is drawn. This process could be repeated
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again to produce an even higher level of equilibrium
with lower prices. By connecting these points
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the downward sloping demand curve is formed.
Now for the reactions of the markets to a
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change in monetary policy. If the central
bank increases the money supply (M) the real
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money supply line shifts outward and the LM
curve shifts outward accordingly.
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Here is the LM curve being formed for M1,
a low supply of money. This forms the first
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point of equilibrium at i1 and Y1.
When the central bank increases the money
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supply to M2 the LM curve shifts down.
The immediate result is that the interest
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rate drops from its original equilibrium to
the intersection of Y1 and the lower LM curve.
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This is based on the assumption that the money
markets adjust quickly. At this point the
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money market is in balance because the point
is on the LM curve, but the interest rate
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is too low for the goods market to be in equilibrium.
At this position there is an excessive demand
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for goods so output and income start to increase.
The Money market adjusts quickly to the increased
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income: an increase in income increases the
demand for money and in turn increases the
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interest rate. This plays out as the point
of equilibrium moves up the LM curve until
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it reaches the IS curve. At this point the
interest rate and Income stabilize and the
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economy reaches equilibrium. So the end result
of the policy of increasing the money supply
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lower interest rates and a higher level of
national income.
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Fiscal policy takes the form of government
spending. The two red aggregate demand functions
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contain exogenous demand, of which government
spending is a factor. Here the IS curve is
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derived using the first value of exogenous
demand. Equilibrium income and interest rate
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are found.
By increasing government spending the red
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aggregate demand curves are shifted upward.
The resulting IS2 is shifted outward. The
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money market quickly responds and a new point
of equilibrium is reached at i2 and Y2. So
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by increasing government spending, the equilibrium
level of national income has risen and the
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interest rate has also risen.
That completes the video. Now you know how
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to find equilibrium in the goods and money
market, how to derive the Aggregate Demand
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curve based on that equilibrium, how the economy
responds in the short run to a change in fiscal
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policy such as increasing the money supply
or a change in monetary policy such as an
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increase in government spending.
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