1 Chp. 9: The IS-LM/AD-AS Model Focus: Interactions among labor market, goods market and assets market. How equilibrium is achieved across the three markets? How disturbances in one market get transmitted to other markets?

2 FE (Full Employment) Line represents equilibrium in the labor market. It relates real rate of interest (r) to the real output (Y) when the labor market is in equilibrium. IS (Investment-Saving) Curve represents equilibrium in the goods market. It is a curve which relates real rate of interest to real output, when goods market is in equilibrium.

3 IS Curve is downward sloping. Any factor other than the current output that affects either the desired saving or investment shifts the IS curve. LM (Demand and Supply of Money) Curve represents equilibrium in the assets market. It is a curve which relates real rate of interest to real output, when assets market is in equilibrium.

4 LM Curve is upward sloping. Any factor other than the current output that affects either the desired money holding or supply of money shifts the LM curve. LM curve is upward sloping because there is inverse relationship between the price of a non-monetary asset and the nominal rate of interest paid by it.

5 General Equilibrium is achieved when all the three markets are in equilibrium simultaneously. It is given by the level of r and Y at which IS, LM, and FE curves intersect each other. Neutrality of Money: Money is neutral when changes in nominal money supply affects price level proportionately without affecting real variables (e.g. Y, r, real wage).

6 Keynesian economists believe that money is neutral in the long run but not in the short run. Classical economists believe that money is neutral in both short and long run. AS-AD model is equivalent to IS-LM model. We get the same results.