The document outlines key concepts related to the goods market, IS curve, money market, and LM curve. It discusses how: - The IS curve shows combinations of interest rates and income where saving equals investment in the goods market. - The LM curve shows combinations of interest rates and income where demand for money equals supply of money in the money market. - Equilibrium in both markets simultaneously determines the equilibrium interest rate and income on the IS-LM model. Fiscal and monetary policies can shift the curves and impact equilibrium.

1. Income Determination Model Including Money and Interest

10. Deriving the IS Curve 45 0 A – i 1 A – i 2 (AD 1 ) i 1 i 2 E 2 E 1 E 1 E 2 Y 1 Y 2 Income, output (a) Y 1 Y 2 Income, output (b) Interest rate Aggregate demand IS (AD 2 )

12. Characteristics of Points that do not lie on the IS curve i 1 Interest Rate Y 2 Y 1 E 3 E 2 E 4 E 1 ESG EDG Income and Output (Y)

14. Demand for Money L 1 =kY 1 - hi i 1 Interest Rate KΔY L 2 =kY 2 - hi Demand for money (L) Figure 1.4

15. Money Market Equilibrium and the LM Curve i 2 i 1 LM L i 1 i 2 L 2 E 1 E 2 E 2 E 1 Y 2 Y 1 L 2 L 1 Y (a) (b)

16. Characteristics of Points that do not lie on the LM curve ESM i 1 Interest Rate Y 2 Y 1 E 1 E 4 E 2 E 3 EDM Income and Output (Y) LM

17. Shift in the LM Curve M 1 /P LM 1 L 1 i 2 i 1 LM L i 1 i 2 M/P E 2 E 1 E 2 E 1 Y 2 Y 1 Y (a) (b)

18. Equilibrium in the Goods and Money Markets (Simultaneous Equilibrium) i 0 Interest Rate Y 0 E Income and Output (Y) Figure 1.8 LM IS

19. Characteristics of Points that do not lie on the IS and LM Curves III II ESM i 0 ESG ESM Interest Rate Y 0 E EDM Income and Output (Y) Figure 1.9 LM EDM EDG ESG EDG I IV IS

20. Region Goods Market Money Market Disequilibrium Output Disequilibrium Interest Rate I ESG Falls ESM Falls II EDG Rises ESM Falls III EDG Rises EDM Rises IV ESG Falls EDM Rises

21. Fiscal Policy I 0 IS 1 E E 11 i 1 Interest Rate Y 0 E 1 Income and Output (Y) LM IS Y 1 Y 11

22. The Transmission Mechanism The Transmission Mechanism Step One Step Two Change in aggregate demand results in adjustments in output and income. Change in real money supply Adjustments in the portfolio, leading to a change in asset prices and interest rates Changes in interest rates lead to change in aggregate demand

23. Monetary and Fiscal Policy LM 1 E 1 E 1 i 1 i 0 Interest Rate Y 0 E Income and Output (Y) LM IS Y 1

24. Policy Effects on Income and Interest Rates Policy Equilibrium Income Equilibrium Interest Rate Expansionary Monetary policy Increase Decrease Expansionary Fiscal Policy Increase Increase Note that expansionary policy (fiscal or monetary) is the policy that is aimed to increase income. Expansionary monetary policy, thus, includes increasing money supply in the economy, while expansionary fiscal policy involves increasing government spending and reducing taxes. We discuss these aspects in detail later chapters.

25. Crowding Out I 0 IS 1 E E 11 i 1 Interest Rate Y 0 E 1 Income and Output (Y) LM IS Y 1 Y 11 LM 1