Comparative Static Analysis

of the Keynesian Model

Macroeconomics I
ECON 309 -- Cunningham

Simple IS-LM Analysis

S (Y ) I (r ) G = 0
M
L(Y , r ) = 0
P
Two equations, two endogenous variables (Y and r), and one
exogenous variable G. Real money supply (M/ P) is taken as
constant since nominal money (M) and (P) are exogenous as well.
Take total differentials:
SY dY I r dr = dG
LY dY + Lr dr = 0
Write in matrix form:
SY
L
Y

Ir dY dG
=

Lr dr 0
2

Simple IS-LM, Continued

Applying Cramers rule for solution:
1
0
dY
=
SY
dG
LY

Ir
Lr
Lr
=
>0
Ir SY Lr + Ir LY
Lr

SY
L
dr
= Y
dG SY
LY

1
0
LY
=
>0
I r SY Lr + I r LY
Lr

So, in a Keynesian economy,

under the conditions given,
cet. par. (i.e., prices), an
increase in government
spending increases GDP and
interest rates.

Because, by assumption, the following hold:

Lr < 0, LY > 0
SY > 0, I r < 0

Extension
What if prices are flexible? To examine this, we must include the
labor market and real wage computation.
w
Nd N = 0
P
Y F (N ) = 0
S (Y ) I (r ) G = 0
M
L(Y , r ) 0
P
Define the following variable as a convenience:
N d w
X =

>0
(w P ) P 2
4

Extension (Continued)
0 1
0 FN
1 0
0
dY
=
0
dG
1
SY
LY

0
0
Ir

Lr

1
FN
0

0
0
Ir

Lr

X
0
0
M
P 2 = Lr FN X > 0
X
Jac
0
0
M
P2

Similarly:
dN
LX
= r >0
dG
Jac
dr
>0
dG
dP
>0
dG
w
d
P <0
dG

(Note that the denominator turns out to be positive.)