Brief #5

Brief #5

Weeks 9&10


Hello Class


Welcome to Weeks 9&10

This chapter introduces ISLM and illustrates its relationship to ADAS

ISLM :  Relates Interest Rates to Output  (ADAS relates prices to output)

ISLM is the cousin of ADAS, they always move at the same time.  People more often talk about ADAS, but ISLM is moving in the background (just out of view).  In reality, you cannot have one without the other.


ISLM Lines:

              FE is the full employment output (similar to LRAS in ADAS model)

              IS is the investment/saving line (the goods market equilibrium)

              LM is the liquidity line  (the asset market equilibrium)


ISLM Movements:                     

              FE moves left and right in response to changes in resources/technology

              IS moves left and right  (G = gov spending   T = taxes)

                                           Increase in total savings (lower G or higher T)  it shifts left

                                           Decrease in total savings (higher G or lower T) if shifts right

              LM moves left or right

                                           Increase money supply or lower prices, it shift right

                                           Decrease money supply or higher prices, it shift left



How ISLM works:

              Starting at long run equilibrium (all three lines intersect at one point).

              There will be a shock that moves one of the lines to create dis-equilibruim

                      It does not matter if the original shock is to LM or IS or FE

              After the shock in the short run, the three lines will no longer intersect at one point

              Short term, the economy will be at the point where LM intersects IS

              The economy will either be in a recession or overheating due to the shock


              Over time, LM will adjust left or right

                      LM is always the line that adjusts to restore long run equilibrium

              After LM adjust, long run equilibrium will return

                      After being either in recession or overheating, the economy will restore itself to potential output

              The only long term effect is that society will have a change in the interest rate (and the price level as seen in ADAS)










ADAS :  Relates Prices to output

              The chapter builds on the previous chapter (Chapter 8)


The variables that link ISLM and ADAS movements are prices and interest rates.


When prices change in ADAS model, it influences movements in ISLM through the LM curve. 


Prices change in ADAS affect ISLM because:

              Increased prices are the same as a reduction in the Money Supply, so LM shift left

              Decreased prices are the same as an increase in the Money Supply, so LM shifts right


Interest Rates change in ISLM affect ADAS because:

              Increased interest rates negatively affect AD, so AD shifts left

              Decrease interest rates positively affect AD, so AD shifts right.


ISLM and ADAS are relational (only ADAS gets more publicity)







Brief #5

Coronavirus Is Different. It’s Rapidly Hitting Supply and Demand.

Fast-spreading disease snarls factories, business travel; White House vows epidemic is ‘not going to sink the U.S. economy’


The headline above is the same as the Brief #4. 

Use your previous brief as a starting point.  Seamlessly work into the paper an enhancement of your previous argument adding the ILSM models where appropriate.  The final product should be a maximum of 3 pages (but you already had up to 2 from the previous brief – you are adding to the prior brief). 

Please make sure to describe what was happening in the U.S. economy using both ISLM and ADAS.  Reference a way in which the above crisis could both be a supply shock and a demand shock (be sure to show what each will do to the economy according to the graphs).   What does it imply about output, prices, interest rates, and employment?