Answer to Question #318547 in Macroeconomics for Li Zhang

Question

 Consider a closed-economy IS-LM model. Assume initially the economy is at medium-run equilibrium. Discuss with the help of graphs the effects of a decrease in consumer sentiment for output, interest rates and price level in the short run as well as in the medium run. Be sure to explain how the economy transitions from short run to the medium run.

Answer 1

Combining the discussion of the LM and the IS curves will generate equilibrium levels of interest rates and output. Note that both relationships are combinations of interest rates and output. Solving these two equations jointly determines the equilibrium. "The IS Curve". The crossing of these two curves is the combination of the interest rate and real GDP, denoted (r*,Y*), such that both the money market and the goods market are in equilibrium.

Comparative statics results for this model illustrate how changes in exogenous factors influence the equilibrium levels of interest rates and output. For this model, there are two key exogenous factors: the level of autonomous spending (excluding any spending affected by interest rates) and the real money supply. We can study how changes in these factors influence the equilibrium levels of output and interest rates both graphically and algebraically.