Notes Essay

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NOTES 9: Putting the Economy Together - IS/LM The purpose of these notes is to review all the markets, and components of those markets, that we have looked at so far. This set of notes - in my opinion - are the most important notes that you will have all quarter. It is a review of the first 6-7 weeks of the class! Let’s start at the beginning: I. A review of the major curves and markets we have covered in our graphical analysis: A. Labor Market: Labor Demand (Nd): Affected by A and K. An increase in either A or K will shift the labor demand curve to the right. Remember, the labor demand curve is just the MPN. Labor Supply (Ns): Affected by the PVLR, value of leisure, taxes and the labor force participation rate. We have studied the labor supply in depth in the first part of the course. If you have questions about these factors and how they shift the labor supply curve, look at Notes 4 and the slides for Topic 2. B. Goods – Money Market: Investment-Savings Curve (IS Curve): This curve is the demand side of the market: Y = C + I + G + NX. This curve is drawn in {Y,r} space. How do changes in REAL interest rates affect output? An increase in (r) will increase the user cost of capital. Higher user cost of capital makes investment more expensive. As a result, firms will invest less (I falls). Given the GDP definition above, a fall in I will reduce output! This is why the goods demand curve slopes downward. Changes in investment due to changes in interest rates DO NOT shift the goods demand curve – it causes a movement along the goods demand curve. Saying that changes in interest rates shift the IS curve because Investment changes is SO WRONG and will likely make me cry like a baby! To review investment, look at Notes 5 and the Topic 3 slides What shifts the IS curve? Anything (besides interest rates) that

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