IS / LM / AD

Getting in Context
 Achievement

• Review the Short Run

• Study de multipliers of Fiscal and

Monetary Policies
 Agenda

• IS /LM /AD: Exercises Proposed

 IS curve
Question 1
𝐶 = 1,000 + 0.1 𝑌 − 𝑇 − 100i
𝐼 = 200 − 100i
𝐺 = 300
𝑇=0
If the level of outcome is 1600, Which is the interest rate that balances the market of
goods?
𝑌 =𝐶+𝐼+𝐺

𝑌 = 1,000 + 0.1 𝑌 − 𝑇 − 100i + 200 − 100i + 300

1,500 − 0.9𝑌
𝑖=
200
𝑖 = 30%
 IS curve
Question 1 (continue) If the income is now 1650 units, Which is now
the interest rate that balances the market of
goods?
𝐶 = 1,000 + 0.1 𝑌 − 𝑇 − 100i 1,500 − 0.9𝑌
𝑖=
𝐼 = 200 − 100i 200
𝐺 = 300 1,500 − 0.9(1650)
𝑖= = 7.5%
200
i i

30%
30%

7.5%

IS IS

1600 1600 1650 Y

Y
 IS curve
Question 2
𝐶 = 1,000 + 0.1 𝑌 − 𝑇 − 100i
𝐼 = 200 − 100i
𝐺 = 350
𝑇=0
Now, suppose the public expenditure increases to 350. If the interest rate is 20%, Which
is income that balances the market of goods?

𝑌 =𝐶+𝐼+𝐺

𝑌 = 1,000 + 0.1 𝑌 − 𝑇 − 100i + 200 − 100i + 350

1,550 − 200𝑖
𝑌=
0.9
1,550 − 200(0.2)
𝑌= ≈ 1,678
0.9
 IS curve
1,550 − 200(0.2) 1,550 − 200(0.166)
𝑌= ≈ 1,678 𝑌= ≈ 1,706
0.9 0.9

20%

7.5%

IS1
IS

1600 1678 1706 Y

 LM curve
Question 3
𝐿! = 3,000 + 0.1𝑌 − 10,000i
𝑀 " = 6,000
𝑃=2
If the income is 9,000, Which is interest rate that balances the money market?

𝑀!
= 𝐿"
𝑃
3,000 = 3,000 + 0.1𝑌 − 10,000i
0.1𝑌
𝑖=
10,000
0.1(9,000)
𝑖= = 9%
10,000
 LM curve
0.1(9,000) If the income goes up to 10,000,
𝑖= = 9% What is the new interest rate?
10,000
0.1(10,000)
𝑖= = 10%
10,000
i

LM

10%

9%

9,000 10,000 Y
 LM curve
Question 4
𝐿! = 3,000 + 0.1𝑌 − 10,000i
𝑀 " = 7,000
𝑃=2
Now, suppose the money supply increases to 7,000. If the income is 9,000, Which is
interest rate that balances the money market?

𝑀!
= 𝐿"
𝑃
3,500 = 3,000 + 0.1𝑌 − 10,000i
0.1𝑌 − 500
𝑖=
10,000
0.1 9,000 − 500
𝑖= = 4%
10,000
 LM curve
Expansionary
0.1(9,000) Monetary Policy 0.1 9,000 − 500
𝑖= = 9% 𝑖= = 4%
10,000 10,000

i i LM
M/P M1/P
LM1

9% 9%

4% 4%

M/P Y
3,000 3,500 9,000
 Aggregate Demand
Question 5
𝐶 = 80 + 0.8𝑌
𝐼 = 50 − 0.5i
𝐺 = 100
𝑚! = 0.5𝑌 − 200i
𝑀"
= 4,000
𝑃
𝑃=1

Show the Aggregate Demand Curve

 Aggregate Demand
Question 5
𝐶 = 80 + 0.8𝑌
𝐼 = 50 − 0.5i
𝐺 = 100
𝑚! = 𝑌 − 0.75i 1st Step: Find the IS curve
𝑀"
= 200 𝑌 =𝐶+𝐼+𝐺
𝑃
𝑃=1 𝑌 = 80 + 0.8𝑌 + 50 − 0.5𝑖 + 100
1 1
𝑌 = 230 − 𝑖
5 2

2
𝑖 = 460 − 𝑌
5
 Aggregate Demand

1st Step: Find the IS curve

The IS curve shows all (i, Y) combinations which balances the market
of goods
i
2
𝑖 = 460 − 𝑌
5
340

Outcome Interest rate

(Y) (i) 300

300 340
260

400 300 IS

Y
260 300 400 500
500
 Aggregate Demand
Question 5
𝐶 = 80 + 0.8𝑌
𝐼 = 50 − 0.5i
𝐺 = 100
𝑚! = 𝑌 − 0.75i 2nd Step: Find the LM curve
𝑀"
= 200 𝑀!
𝑃 = 𝑚"
𝑃
𝑃=1
200 3
=𝑌− i
𝑃 4

4 800
𝑖= 𝑌−
3 3𝑃
 Aggregate Demand
2nd Step: Find the LM curve

The LM curve shows all (i, Y) combinations which balances the money market.
Remember in our example: P=1

4 800
𝑖= 𝑌− i
3 3𝑃 LM
216
Outcome Interest rate
(Y) (i)
200
341 188

188
350 200

362 216
Y
341 350 362
 Aggregate Demand
Question 5
𝐶 = 80 + 0.8𝑌 3rd Step: Find the AD curve
𝐼 = 50 − 0.5i 2 4 800
𝐺 = 100 460 − 𝑌 = 𝑌 −
5 3 3𝑃
𝑚! = 𝑌 − 0.75i
𝑀" 4,000
6900 − 6𝑌 = 20𝑌 −
= 200 𝑃
𝑃
4,000
𝑃=1 = 26𝑌 − 6,900
𝑃

4,000
𝑃=
26𝑌 − 6,900
 Aggregate Demand
3rd Step: Find the AD curve
The AD curve is plotted in the quadrant (Y, P)

4,000
𝑃=
26𝑌 − 6,900 P

Outcome Price
(Y) 3
(P)

342.31 2
2
316.67 3 Y
342.31 316.67 303.85
AD
303.85 4
 Aggregate Demand
(Graphically)
Question 5 i
( LM
𝐶 = 80 + 0.8𝑌 IS: 𝑖 = 460 − )
𝑌
𝐼 = 50 − 0.5i # %&&
LM: 𝑖 = 𝑌 −
$ $'
𝐺 = 100 292.31

𝑚" = 𝑌 − 0.75i
𝑀!
= 200 IS
𝑃
Y
𝑃=1 P 419.23
2 4 800
460 − 𝑌 = 𝑌 −
5 3 3𝑃
6,900 − 6𝑌 = 20𝑌 − 4,000
P=1
𝒀 ≈ 𝟒𝟏𝟗. 𝟐𝟑
i≈ 𝟐𝟗𝟐. 𝟑𝟏
AD
Y
419.23
 Aggregate Demand
Question 5 What if the Fed buy bonds for 50 units of money?
𝐶 = 80 + 0.8𝑌 250 3
=𝑌− i
𝐼 = 50 − 0.5i 𝑃 4
𝐺 = 100 4 1,000
𝑖= 𝑌− New LM curve
3 3𝑃
𝑚" = 𝑌 − 0.75i
𝑀!
= 250
𝑃 Finding the New AD curve:

𝑃=1 2 4 1,000
460 − 𝑌 = 𝑌 −
5 3 3𝑃
5,000
= 26𝑌 − 6,900
𝑃

5,000
𝑃= New AD curve
26𝑦 − 6,900
 Aggregate Demand
(Graphically)
i
LM

LM1
2 4 1,000
460 − 𝑌 = 𝑌 −
5 3 3 292.31

6,900 − 6𝑌 = 20𝑌 − 5,000 276.92

𝒀 ≈ 𝟒𝟓𝟕. 𝟔𝟗
IS
i≈ 𝟐𝟕𝟔. 𝟗𝟐
Y
P 419.23 457.69

P=1

AD1
AD
Y
419.23 457.69
 IS & LM multipliers
𝑌 = 𝐶 𝑌 + 𝐼 𝑌, 𝑟 + 𝐺0
𝐶 = 𝐶(𝑌)
𝑑𝑌 = 𝐶, 𝑑𝑌 + 𝐼, 𝑑𝑌 + 𝐼- 𝑑𝑟 + 𝑑𝐺0
𝐼 = 𝐼(𝑌, 𝑟)
𝐺 = 𝐺0 IS curve: − 𝟏 − 𝑪𝒀 − 𝑰𝒀 𝒅𝒀 + 𝑰𝒓 𝒅𝒓 = −𝒅𝑮𝟎
𝐿! = 𝐿(𝑌, 𝑟)
𝑀
M =s 𝑀
𝑃 𝐿 𝑌, 𝑟 =
𝑃

𝑃𝑑𝑀 − 𝑀𝑑𝑃
𝐿, 𝑑𝑌 + 𝐿- 𝑑𝑟 =
𝑃(

𝟏 𝑴
𝑳
LM curve: 𝒀 𝒅𝒀 + 𝑳𝒓 𝐝𝐫 = 𝐝𝐌 − 𝒅𝑷
𝑷 𝑷𝟐
 IS & LM multipliers
IS curve: − 𝟏 − 𝑪𝒀 − 𝑰𝒀 𝒅𝒀 + 𝑰𝒓 𝒅𝒓 = −𝒅𝑮𝟎
𝟏 𝑴
LM curve: 𝑳𝒀 𝒅𝒀 + 𝑳𝒓 𝒅𝒓 = 𝑷 𝐝𝐌 − 𝑷𝟐 𝒅𝑷

−1 0 0 𝑑𝐺
− 1 − 𝐶# − 𝐼# 𝐼$ 𝑑𝑦 1 −𝑀 𝑑𝑀
=
𝐿# 𝐿$ 𝑑𝑟 0
𝑃 𝑃% 𝑑𝑃
AX = BY
X = A-1BY

1 𝐿$ −𝐼$ −1 0 0 𝑑𝐺
𝑑𝑦 1 −𝑀 𝑑𝑀
=
𝑑𝑟 𝐴 −𝐿# − 1 − 𝐶# − 𝐼# 0
𝑃 𝑃% 𝑑𝑃
−𝐼$ 𝑀
𝑑𝑦 1 −𝐿$ 𝑃
𝐼$
𝑃%
𝑑𝐺
= 𝑑𝑀
𝑑𝑟 𝐴 − 1 − 𝐶# − 𝐼# 1 − 𝐶# − 𝐼# 𝑀
𝐿# 𝑑𝑃
𝑃 𝑃%

Where, 𝐴 = − 1 − 𝐶# − 𝐼# 𝐿$ − 𝐿& 𝐼$ > 0

 IS & LM multipliers
𝐴 = − 1 − 𝐶# − 𝐼# 𝐿$ − 𝐿& 𝐼$ > 0

−𝐼$ 𝑀 𝑑𝐺
−𝐿$ 𝐼$
𝑑𝑌 1 𝑃 𝑃%
= 𝑑𝑀
𝑑𝑟 𝐴 − 1 − 𝐶# − 𝐼# 1 − 𝐶# − 𝐼# 𝑀
𝐿# 𝑑𝑃
𝑃 𝑃%

Fiscal Policy Monetary Policy

𝑑𝑌 −𝐿- + −𝐼-
= = >0 𝑑𝑌 𝑃 −𝐼- +
𝑑𝐺 𝐴 + = = = >0
𝑑𝑀 𝐴 𝑃𝐴 +

𝑑𝑟 𝐿, + − 1 − 𝐶, − 𝐼,
= = >0 𝑑𝑟 𝑃 − 1 − 𝐶, − 𝐼, −
𝑑𝐺 𝐴 + = = = <0
𝑑𝑀 𝐴 𝑃𝐴 +
 Conclusions

• An expansionary Monetary Policy has a

positive impact on the outcome and a negative
impact on interest rates in short run.
• An expansionary Fiscal Policy has a positive
impact in both outcome and interest rates in the
short run.
 Readings

• Hubbard & O’Brien, Chapter 27