Chapter 20

• in
chapter we will consider investment endogenous and the price level is fixed
this as
,
.

Investment is composed of Capital equipment (goods) Inventories and Residential housing

•
:
, ,
.

Investment As
Go

Long -
run short -
run

investment the capital increases

changes in investment affect aggregate
stock and the size of potential GDP .

spending (AG) and the level of GDP and

the size of GDP gap .

AY =
¥ .
sI

•
Two for financing the investment domestic saving inform of ① firms retained
sources :
'

profits and households saving ② borrowing of savings that have been made abroad
'
,
.

• The basic motive of investments is the expectation of profits .

The determinants of investment : Price ( P)

•
,
Real interest rate ( I) ,
Profits
Theenology , Expectation of future demand .

•
Desired investment spending (E) depends the real rate of interest ( it , unlike the
on

demand for money that depends on the nominal rate of interest ( t) .

Nominal interest rate G) Inflation rate (SP) fisher

"
Real interest rate Ci)
"

eq
•
-
= .

when the price level G) is fixed i 1-

•
=

•
If inventories are being added to the addition is current investment; if inventories are
,

being reduced the amount of the reduction is disinvestment

,
.

The transfer of ownership of

•

existing houses do not affect GDP because they are not ,

part of current production (In other words : only new houses built are included)
.

I = -
fi - -
-
-
-
- •
-
i

£ →

ÉEÉ%
£
- - - -

Investment slope of curve real interest rate

•
Investment and rate of interest are negatively related .

;
. - =

• The slope of the curve (f) = St /AI

GE te
,
-
- - -

p
- -
-

• if u;) 9 : then I b. ,
and vice versa . I ;
Bb

!* This implies that when v9 the number of

-

new to It
. ,

be reduced disinvestment Desired investment expenditure

building will , a in

inventories will occur also .

(The investment demand function)

Nabeel
 • The curve : showsallthiscombinationsol-GDPandintetesl-tatefotwh.ch aggregate
desired spending CAE ) equals actual output (GDP ,Y) .

ol-GDPandi-ealinta-esttatefa-whichl-hesumof.at/injecl-ions(
•
IS curve in other words : the combination

G.IE/ip)equa1sthesumofallleakagesCT.S,Imp ) .

•
IS curve in other words : the combination ol-GDPandrealinta-esttateol-whiic.tn total
investment equals total saving CS ) .

•
Thess cutvetelal-eswithtealintetestrate.whetasLMcutve.ie/atestol-henominal .

•
IS stands for : Investment Saving > AE=Y
AE
•
How dowegefthet-scui.ve ? •
AE ,

• The IS curve is negatively sloped because a fall !

inthe interest rate increases desired spending and I As
,

hence increases equilibrium GDP .

I i
,
• Low interest rate __
Higher GDP equilibrium .
oi ! i. Y
Gi Yi "
'

•
we.cat/l-hepoinl-sontheIScutvepointsofr ; I
spending equilibrium l-odisfinguishfhemfi.am points
'
,
' '

onl-he.LU which is called monetary equilibrium

curve
'

I
, .

• An increase in exogenous spending shifts the -1-5 % - - - -

• ,

'
i
curve to the rightindicating higher level of GDP
'

,
a
" IS
t
. - - - -
-

:
- -

•
If thetscutveshiffedfofhepightiandpgoq ! ×
4¥
.

,
% CGDP)
• The IS relates to the goods market whenas
curve /

the Ltl curve relates to the money market .

•
The shift right when :( 9 -14,69 ,E×p9ImpbotTb and then +9849
curve ,

• The IS curve shift left when :(b. -1-6,66 ,E×pk,Imp9otT&andthentk&Yk

,

•
If -169 then IS curve shift right and vice versa ,
.

•
shift right means increases and left means decreases r
, .

• The change in GDP caused by the rightward shift in AECY

output will 'd
the Iscuivecanbecomputedby :
GDP = •

tdexogenuous AGH
cis the MP to spend output will & Is

c= MPC.CI f) - -
m
×

Nabeel
 theslopeoftdemand
it
The equation of -15 i The slope d- IS curve
lf= #
curve

1-j.gl?---,MPc-isI------------i-----------t-----PrivateSavingCs)=I-
i. = constant -

Public
saving (6--1) Saving abroad (Exp
+ -

Imp)
- - -
- - - - - - - - -
- - - - - - - - - -
- - - - - - - - -

•
Equilibrium d- the macroeconomic system requires both the goods market (spending) and
the money market (asset) bein equilibrium .

GDP got

(Buy Bonds) 1- got

GDP got

1- go 't
( sell Bonds)

1-
got
( Buy Bonds)
GDP got

✗ got (sell Bonds)

GDP got

•
If both markets money and goods in equilibrium this means that Ms=M°
and AE=Y .

•
If IS curve shifts ,
GDP and 1- are positively related .GS shift tight :Y4&t4)
•
If LM curve shifts ,
GDP and rate negatively related .AM shift tight :X Itb )
• IS curve
equation : i= constant -

slope 't .

• LM curve equation : i= constant +

slope 't .

Nabeel
 LM LMO
LM ,

G, Eo
19 -
- - - - - -

• 1g - - - - -
•

-8-0 ! ISI !
1g - - - -

" - - - -
-
§
,

¥ ! Iso
É ; Is

% % Yo %

Effects d- shifts in -15 curve Effects of shifts in Lmcutve

* arightwardshiffinthe.IS curve is * aiightwatdshiftinthehtlcutveis
caused by an increase in
exogenous
caused byanincteaseinleallhsot
component . a decrease in teal MD .

* airightwardshiffinthetscurve • arightwatdshiftinl-helmcui.ve
raises the equilibrium values d. both increases GBP1M and decreases the
the GDPCY) and interest rated) .
interest eaten .

• people will sell bonds .

* people will buy bonds .

* vicevetsaisftue . • vice versa is true .

- -
- - - - - - - - - - - -
-
- - - - - - - - - -
- - - - -

•
When Mst : Buy Bonds & when Msk : Sell Bonds .

•
Fluctuations in exogenous spending cause
changes inGDPandi-to.be positively
associated with eachother .

•
fluctuations inthelealmoneysupplycns) cause changes in GDP and into be negatively
associated with eachother .

Nabeel
• The interest constant
-

multiplier is shown by the horizontal shift in the IS curve in

response to a- shift in some

component of exogenous spending .

•
The interest variable IS -2M
-

multiplier is always smaller than the interest constant -

multiplier because of the crowding out effect

,
-
.

•
The rise in the interest rate that accompanies a rise in GDP with a constant real

money supply reduces the value of the multiplier .

Crowding out effect : refers to the lowering of investment spending whenever

-
a rise
in GDP is accompanied by a rise in the interest rate ; spending is
crowded out by the rise in the interest rate that occurs when
the
quantity of money demanded rises because GDP rises .

•
The central bank can avoid the crowding out effect by holding the interest rate constant
-

which requires that it allows the money supply to expand as the demand for money
increases because of the increase in GDP .

• watch in YouTube explanation of IS L M model and

-

crowding out effect

-
:

https://youtube.com/playlist?list=PLLQgsx_IUfnrgCY6h1hpaaCbdTJN44grw

Nabeel