Econ 101: Intermediate Macroeconomics Lecture 9 Review

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What does the IS curve summarize?

The relationship between the interest rate and income

How does an increase in government spending affect the IS curve?

Shifts the curve to the right

What is the Theory of Liquidity Preference concerned with?

The relationship between money supply and money demand

What happens to interest rates when the central bank reduces the money supply?

Interest rates increase

How do safety precautions during Covid-19, leading to a reduction in cash usage, affect the LM curve?

Shifts the curve to the right

What is the IS curve?

A graph of all combinations of real interest rate and income that result in goods market equilibrium

How does a decrease in real interest rate affect the IS curve?

Increases investment spending, driving up total planned spending

Which factor has a negative relationship with investment spending?

Real interest rate

What happens to output if the real interest rate decreases?

Output increases

How does a fall in the interest rate impact investment spending?

Motivates firms to increase investment spending

What is the equation for the IS curve?

$Y = C(Y - T) + I(r) + G$

How does a decrease in the real interest rate impact planned investment spending?

Planned investment spending increases

What happens to total planned spending (PE) when firms increase investment spending due to a fall in the interest rate?

Total planned spending increases

If the real interest rate decreases from $r_1$ to $r_2$, what happens to planned investment?

Planned investment increases

Which of the following accurately describes the relationship between investment spending and the real interest rate on the IS curve?

Investment spending and the real interest rate have an inverse (negative) relationship

In the context of the IS-LM model, how does an increase in government spending affect the LM curve?

The LM curve remains unaffected as it is only influenced by changes in the money supply

How does a reduction in cash usage due to Covid-19 safety precautions affect the IS curve in the IS-LM model?

The IS curve shifts to the left due to a decrease in income and aggregate demand

What is the impact of a decrease in real money demand on the LM curve in the IS-LM model?

The LM curve shifts up due to an increase in money demand

How does an increase in real interest rates affect the IS curve in the IS-LM model?

The IS curve shifts to the left due to a decrease in investment spending

What happens to investment spending if there is an upward shift in the LM curve in the IS-LM model?

Investment spending decreases due to higher interest rates

Study Notes

IS Curve

  • The IS curve summarizes the various combinations of the real interest rate and the level of real income that equilibrium in the goods and services market.
  • The IS curve shows the relationship between the real interest rate and the level of real income.

Effects of Government Spending and Real Interest Rate on IS Curve

  • An increase in government spending shifts the IS curve to the right.
  • A decrease in the real interest rate increases planned investment spending, leading to an increase in total planned spending and a shift to the right of the IS curve.
  • The equation for the IS curve is not provided.
  • A decrease in the real interest rate from r1 to r2 increases planned investment.
  • The real interest rate and investment spending have a negative relationship on the IS curve.

LM Curve

  • The Theory of Liquidity Preference is concerned with the demand and supply of money.
  • A reduction in cash usage due to Covid-19 safety precautions increases the demand for money, leading to an upward shift of the LM curve.
  • A decrease in real money demand shifts the LM curve to the right.
  • An increase in real interest rates leads to a decrease in the demand for money, shifting the LM curve to the left.

Effects of Interest Rate and Government Spending on Output

  • A decrease in the real interest rate leads to an increase in output.
  • An increase in government spending leads to an increase in output.

Effects of Interest Rate on Investment Spending

  • A fall in the interest rate leads to an increase in investment spending.
  • A decrease in the real interest rate leads to an increase in planned investment spending.

IS-LM Model

  • An increase in government spending has no effect on the LM curve in the IS-LM model.
  • A reduction in cash usage due to Covid-19 safety precautions has no effect on the IS curve in the IS-LM model.
  • An upward shift in the LM curve in the IS-LM model leads to an increase in investment spending.

Review previous lessons on The Keynesian Cross, IS Curve, LM Curve, Short Run Equilibrium, and the IS-LM model. Explore the components and concepts of the IS Curve and the Investment-Saving Curve.

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