Macroeconomics

Summary

1.

The IS –LM model is a general theory of the aggregate demand for goods

and services. The exogenous variables in the model are fiscal policy, mone-

tary policy, and the price level. The model explains two endogenous

variables: the interest rate and the level of national income.

2.

The IS curve represents the negative relationship between the interest rate

and the level of income that arises from equilibrium in the market for

goods and services. The LM curve represents the positive relationship

between the interest rate and the level of income that arises from equilibri-

um in the market for real money balances. Equilibrium in the IS –LM

model—the intersection of the IS and LM curves—represents simultaneous

equilibrium in the market for goods and services and in the market for real

money balances.

3.

The aggregate demand curve summarizes the results from the IS –LM

model by showing equilibrium income at any given price level. The aggre-

gate demand curve slopes downward because a lower price level increases

real money balances, lowers the interest rate, stimulates investment

spending, and thereby raises equilibrium income.

C H A P T E R   1 1

Aggregate Demand II: Applying the IS-LM Model

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P A R T   I V

Business Cycle Theory: The Economy in the Short Run

P R O B L E M S   A N D   A P P L I C A T I O N S

each case, explain what the Fed should do to

keep income at its initial level.

a. After the invention of a new high-speed

computer chip, many firms decide to upgrade

their computer systems.

b. A wave of credit-card fraud increases the fre-

quency with which people make transactions

in cash.

c. A best-seller titled Retire Rich convinces the

public to increase the percentage of their

income devoted to saving.

3.

Consider the economy of Hicksonia.

a. The consumption function is given by

C

= 200 + 0.75(Y − T ).

K E Y   C O N C E P T S

Monetary transmission 

mechanism

Pigou effect

Debt-deflation theory