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.
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)
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)
Coronavirus Is Different. Itâ€™s Rapidly Hitting Supply and Demand.
Fast-spreading disease snarls factories, business travel; White House vows epidemic is â€˜not going to sink the U.S. economyâ€™
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 â€“ 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?