Chp. 9: The IS-LM/AD-AS Model

1
Chp. 9 The IS-LM/AD-AS Model

• Focus
• Interactions among labor market, goods market and
  assets market.
• How equilibrium is achieved across the three
  markets?
• How disturbances in one market get transmitted to
  other markets?

2

• FE (Full Employment) Line represents equilibrium
  in the labor market. It relates real rate of
  interest (r) to the real output (Y) when the
  labor market is in equilibrium.
• IS (Investment-Saving) Curve represents
  equilibrium in the goods market. It is a curve
  which relates real rate of interest to real
  output, when goods market is in equilibrium.

3

• IS Curve is downward sloping. Any factor other
  than the current output that affects either the
  desired saving or investment shifts the IS curve.
  
• LM (Demand and Supply of Money) Curve represents
  equilibrium in the assets market. It is a curve
  which relates real rate of interest to real
  output, when assets market is in equilibrium.

4

• LM Curve is upward sloping. Any factor other
  than the current output that affects either the
  desired money holding or supply of money shifts
  the LM curve.
• LM curve is upward sloping because there is
  inverse relationship between the price of a
  non-monetary asset and the nominal rate of
  interest paid by it.

5

• General Equilibrium is achieved when all the
  three markets are in equilibrium simultaneously.
  It is given by the level of r and Y at which IS,
  LM, and FE curves intersect each other.
• Neutrality of Money Money is neutral when
  changes in nominal money supply affects price
  level proportionately without affecting real
  variables (e.g. Y, r, real wage).

6

• Keynesian economists believe that money is
  neutral in the long run but not in the short run.
  Classical economists believe that money is
  neutral in both short and long run.
• AS-AD model is equivalent to IS-LM model. We get
  the same results.