IS – LM model and
Aggregate Demand (AD) in
close economy
CONTENT
v The overview of the model
v The balance in good market and IS curve
v The balance in monetary market and LM curve
v Simultaneous balance in commodity and currency
markets
v The impact of fiscal policy
v The impact of monetary policy
1. OVERVIEW OF THE MODEL
v K n o w n a s t h e H i ck s - H a n s e n m o d e l , i t w a s
introduced and developed by economists John
Hicks (1904-1989) and Alvin Hansen (1887 - 1975)
in the 1930s.
v Explains Keynes's very famous and influential work
"General theory of employment, interest and money".
1. OVERVIEW OF THE MODEL
v The economy in IS - LM model include two
markets:
• The good market is represented through the
IS (Investment – Saving) curve.
• The money market is represented by the LM
curve (Liquidity preference – Money Supply).
§ Interest rates affect both investment and
demand for money => the main linking factor
of the components in the IS-LM model.
1. OVERVIEW OF THE MODEL
v This model clearly shows how to determine
aggregate demand through the interaction between
the good and monetary markets.
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
2.1. The Keynesian cross model
2.2. Interest rate, investment and IS curve
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
2.1. The Keynesian cross model
• The main tool for constructing the IS curve is the
Keynesian cross model.
• Expected expenditure (planned expenditure) is
the amount of money that households,
businesses and shareholders plan to spend to
buy goods and services.
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
2.1. The Keynesian cross model
The difference between planned expenditure and
actual expenditure is the unplanned investment in
inventory.
hàng bán và hàng dự đoán=> hàng tồn kho
+ Goods sold < expected: inventory increased
+ Goods sold > expected: inventory decreased
=> Actual expenditure is different from expected
expenditure.
inventory bao gồm : raw
mater, semi gì đó, FG
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
2.1. The Keynesian cross model
In a simple closed economy, the total planned
expenditure (APE/AE – Aggregate Planned
Expenditure) of the economy is equal to:
APE = C+ I + G
- With: C = C(Y-T)
I=�
G=�
T=�
=>
APE = C (Y- �) + � + �
AGGREGATE PLANNED EXPENDITURE
APE
APE= C(Y – ) +
MPC
Y
The slope of APE curve is MPC
+
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
v The economy reaches equilibrium when:
Planned expenditure = Actual expenditure
APE = Y
tổng thu nhập bằng tổng
chi tiêu= cân bằng
THE KEYNESIAN CROSS MODEL
APE
Y = APE
tổng chi tiêu
APE
A
điểm cân bằng
Planned
expenditure
450
Y
Equilibrium
income
tổng thu nhập
THE KEYNESIAN CROSS MODEL
v Government purchases and expenditure
multiplier
chính phủ gia tăng tổng chi tiêu=> tác động lên tổng sản lượng
G => APE curve shift upward => Y rises
APE
điểm cân bằng 2
delta Y= m x (dt G)
B
APE= Y
APE2
APE1
G A
Y
G tăng=> APE tăng=> y
tăng
45o
Y1
Y2
Y
THE KEYNESIAN CROSS MODEL
v The changing process of income
v When Government purchase increases G:
- Initial change in Government purchase: G
- Thay đổi ban đầu trong nước mua hàng của CP: G
- The first change in consumption:
MPCx G
- The second change in consumption: MPC2 x G
- The third change in consumption:
- …
MPC3 x G
MPC=dtC/dtYd
=> dtC= MPC* dtYd= MPC* dtG
THE KEYNESIAN CROSS MODEL
v The changing process of income
The final increase in income is:
Y = (1 + MPC + MPC2 + MPC3 +…)G
or
(2.1)
With: m = Y/G then:
(m>1)
THE KEYNESIAN CROSS MODEL
v
The changing process of income
•
m is called expenditure multiplier of
Government
• Meaning: it shows how much the output
increases when Government expenditure
increases extra 1 unit.
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
2.2. Interate rate, investment and IS curve
2.2.1. Definition
- The IS (Investment – Saving) curve is a set of
different combinations of interest rates and output
at which the goods market is in equilibrium.
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
2.2. Interate rate, investment and IS curve
2.2.2. How to build IS curve
- With initial interate rate r 1 : I = I(r 1 ) => APE 1 =>
identify E1 (r1, Y1).
- With r2: I = I(r2) => APE2 => identify E2 (r2, Y2)
- Connect E1 and E2 -> IS curve
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
APE
APE1
APE2
I
Y
ở lãi suất r1 sẽ có
lượng đầu tư I1
- mà I trong APE nên sẽ
có đường APE1
Y2
lãi suất R1 tăng=> đầu
tư giảm xuống I2 => tổng
chi tiêu nền kinh tế
giảm xuống APE2
=> ta có mức sản lượng
Y2 và lãi suất R2 sẽ có
điểm cân bằng E2
r
r2
r1
chi phí tăng lên đầu tư
giảm xuống => I2
c
r
r2
E2
với Y1 và R1 sẽ có điểm
giao E1( điểm sản lượng
cân bằng)
E1
r1
I
I2
Y1
I1
I
IS
Y2
Y1
đường IS( invesmentsaving) thể hiện mối
quan hệ giữa lãi xuất
(IR) và output
Y
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
2.2. Interate rate, investment and IS curve
2.2.3. Feature
- IS curve slopes downward reflecting inverse
relationship between interest rate and income.
- The slope is negative.
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
2.2. Interate rate, investment and IS curve
2.2.4. The shift of IS curve
When r unchanges, other factors change would
shift IS curve. Other factors are:
- Increase in household consumption
- Increase in private sector’s investment
- Increase in Government expenditure on G&S
2. THE EQUILIBRIUM ON THE GOOD
MRKET AND IS CURVE
APE
E2
APE2
APE1
E1
Y
r
E1
đường IS dịch chuyển khi
sản lượng thay đổi , lãi
xuất ko đổi
- các yếu tố tác
động( C,G,I)
E2
r1
IS2
IS1
Y1
Y2
Y= G/ (1-MPC)
Y
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
3.1. Liquidity preference theory
3.2. Interest rate, investment and LM curve
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
3.1. Liquidity preference theory
- The equilibrium condition in the monetary market
MS = MD
- MS depends on:
+ M – policy variable determined by CB.
+ P – exogenous variables in the model
- MD (L) epends on r and Y
=> The monetary market is in equilibrium when:
M/P = L(r, Y)
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
r
r*
MS
A
L(r,Y)
Real money
balances
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
3.2. Interest rate, investment and LM curve
3.2.1. Definition
- The LM (Liquidity preference – Money Supply)
curve is a set of different combinations of interest
rates and output at which the money market is in
equilibrium, with the real money supply
remaining constant.
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
3.2. Interest rate, investment and LM curve
3.2.2. How to build LM curve
- With Y1, the money market balances at r1 => E1
(r1, Y1)
- With Y2, the money market balances at r2 => E2
(r2, Y2)
- Connect E1 and E2 -> LM curve.
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
r
MS
r
r2
B
r1
A
thị trường cân bằng vs
mức r1 và Y1
E2
r2
r1
LM
E1
L2
L1
L : cầu tiền
M/P
M/P
Y1
Y2
y : thu nhập
(a) Real monetary market
(b) LM Curve
Lm là đường tập hợp điểm
cân bằng của thị truòng
Y
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
3.2. Interest rate, investment and LM curve
3.2.3. Feature:
- LM curve slopes upward reflecting proportionate
relationship between income and interest rate.
LM shift khi Y ko đổi
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
3.2. Interest rate, investment and LM curve
3.2.4. The shift of LM
- When Y unchanges, a change in money supply/
money demand would shift LM curve.
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
3.2. Interest rate, investment and LM curve
3.2.4. The shift of LM curve
Ex1: Suppose the Central Bank increases the
money supply, under the condition that the price
level P remains unchanged, the real money supply
will increase.
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
MS1
MS2
MS : đường cung tiền
r
r
r1
r2
LM1
E1
r1
E2
LM2
E1
r2
E2
cung tiền tăng làm cho
LM dịch chuyển về phía
bên phải
L
giá ko đổi
M/P
Y
3. THE EQUILIBRIUM ON THE MONETARY
MRKET AND LM CURVE
3.2. Interest rate, investment and LM curve
3.2.5. The shift of LM curve
Example 2: Suppose an increase in credit card
fraud causes consumers to use cash more often
to make transactions.
4. SIMULTANEOUS BALANCE IN GOOD
AND MONETARY MARKETS
IS: Y = C(Y-T) +I(r) +G
LM: M/P = L(r, Y)
xác định r khi thoả mãn
điều kiện hệ phương
trình IS=LM
cân bằng khi LM giao IS
5. THE IMPACT OF FISCAL POLICY
5.1. Multiplier effect
hiệu ứng cấp số nhân
5.2. Investment crowding out effect
hư lấn át đầu tư
5. THE IMPACT OF FISCAL POLICY
5.1. Multiplier effect
vC a s e 1 : G o v e r n m e n t e x p e n d i t u r e i n c r e a s e s ( G
increases -> APE increases -> IS shift right)
tăng chi tiêu kv công=>
tăng khoảng dtG
r
LM
B
r2
A
IS2
r1
IS1
Y
Y1
Y2
y tăng gấp m lần dtG
5. THE IMPACT OF FISCAL POLICY
5.1. Multiplier effect
v Case 2: decrease T (T -> YD -> C -> IS )
giám
nhân
nhập
tăng
thuế thu nhập cá
ảnh hưởng Yd( thu
khả dụng) tăng => c
-> IS tăng
LM
r
B
r2
A
r1
IS2
IS1
Y1
Y2
Y
5. THE IMPACT OF FISCAL POLICY
5.2. Investment crowding out effect
r
LM
B
r2
- thị trường hàng hoá
chính phủ tăng mức mua
sắm -> dtG tăng-> APE
tăng -> IS tăng => shift
phải
( hiện tượng cấp số
nhân)
- thị trường tiền tệ
thu nhập tăng lên Y1’ ->
câù tiền tăng lên-> lãi
xuất tăng lên
A
r1
IS2
y1 tăng lên y1’ : nhu
cầu sử dụng hàng hoá
tăng ( trong thị trg
hàng hoá), do tác động
từ thị trường tiền tệ
nên lãi suất sẽ tăng
lên=> quay về điểm B
y1’ tăng lên y2 gọi là
hiện tg lấn át đầu tư
IS1
Y1
Y
2
slide cuối trong FF
Y’1
Y