Introduction to

Macroeconomics

Rayees Ahmad Sheikh

25-09-2024
Agenda

• Introduction to Macroeconomics?

• Why do we study Macroeconomics?

• A brief Indian Context

2
 Introduction to Macroeconomics

Course Outline
Introduction Measuring Economy

Economy in Short Run

Stabilisation Policies
Goods Money IS-LM
Monetary Policy
Market Market Model
Fiscal Policy
Economy in Long Run Run
Aggregate Demand and Supply Phillips Curve

Open Economy in Short and Long Run

Extensions of IS-LM in Extensions of IS-LM in International Adjustments and

Mobility of Goods Mobility of Capital Interdependence

Budget, Public Debt, and Inflation

3
 Introduction to Macroeconomics

Evaluation
Individual Time/Sessions
S. No Weightage
Component Covered

1 Quiz 1 10 After 5th

2 Mid Term 35 10th

3 Quiz 2 10 15th

4 End Term 35 20th

5 Class Participation 10 -

4
 Introduction to Macroeconomics

Exam Pattern

• Predominantly Multiple Choice Questions

• Class Participation – Quantity vs. Quality

- response to questions asked during lecture

- questions asked during lecture
- take home questions

5
 Introduction to Macroeconomics

General Class Etiquettes

• Use of Mobile Phones and Laptops -------- NO/Only

those allowed by office

• Late Commers -------------- NO

• Leaving Class in between ---------- NO

• One Question at a time

6
 Introduction to Macroeconomics

The Beginning….

7
 Introduction to Macroeconomics

The Beginning….

• A mathematician, and an economist apply for the same job.

• Both are asked same question….

What is 1+1 equal to?

Mathematician answers 2.

What do think Economist might have answered?

8
 Introduction to Macroeconomics

Answer
"What do you want it to equal?”

• Aggregate is more or less than sum of individual factors

• Is it true?

Adam Smith and Invisible Hand

9
 Introduction to Macroeconomics

Macroeconomics
Macroeconomics studies the behavior of an overall economy

- goes beyond the households and firms behavior

• All Goods & Services - not a particular market

• Incomes of All – not a firm or an individual

10
 Introduction to Macroeconomics

Macroeconomics focuses on four markets

• Goods or output market – the market for goods available for
immediate or current use

• Bond market – the market for future goods

• Money market – asset used to purchase/sell goods

• Labour market – market for factor of production that produces

goods

What is the benefit/disadvantage of aggregation?

11
 Introduction to Macroeconomics

Origin of Macroeconomics
• Macroeconomics is of recent Origin.

• 1930 Great recession

12
 Introduction to Macroeconomics

Some Important Macroeconomic Variables

• National Income

• Aggregate Demand

• Aggregate Supply

• Price Level

• Unemployment

13
 Introduction to Macroeconomics

How do Economists Think?

• Economic Models

….. Model is simplified versions of a complex reality

• These models are used to:

- show relationships between variables

- explain the economy’s behavior
- devise policies to improve economic performance

14
 Introduction to Macroeconomics

Introduction
Three Important Macroeconomic Models

• Very Long Run (Over Decades)

• Long Run (Few Years)

• Short Run (Less than a Year)

15
 Introduction to Macroeconomics

What is Short and Long Run in Macroeconomics

• Fixed Cost (Factors)

• Variable Cost (Factors)

16
 Introduction to Macroeconomics

Long Run
• Very Long Run
- domain of growth theory >> focuses on growth of the
production capacity of the economy

• Long Run
- A snapshot of the very long run model, in which capital
and technology are largely fixed
- The given level of capital and technology determine the
level of potential output
- Output is fixed, but prices are determined by changes in
Demand
17
 Introduction to Macroeconomics

Determination of Supply: The Very Long Run

Source: Macroeconomics (Dornbusch et. al. 12th ed. Page: 7

18
 Introduction to Macroeconomics

Long Run

The aggregate supply (AS) curve depicts, for each given

price level, the quantity of output firms are willing to
supply.

The aggregate demand (AD) curve presents, for each

given price level, the level of output at which the goods
markets and money markets are simultaneously in
equilibrium.

19
 Introduction to Macroeconomics

Aggregate Demand and Supply: The Long Run

Source: Macroeconomics (Dornbusch et. al. 12th ed. Page: 7

20
 Introduction to Macroeconomics

Short Run

Short Run - business cycle theories

- Changes in AD determine how much of the productive

capacity is used and the level of output and unemployment

-Prices and Wages are fixed in this period, but output is

variable

21
 Introduction to Macroeconomics

Aggregate Demand and Supply: The Short Run

Source: Macroeconomics (Dornbusch et. al. 12th ed. Page: 8)

22
 Introduction to Macroeconomics

Aggregate Demand and Supply: The Medium Run

Source: Macroeconomics (Dornbusch et. al. 12th ed. Page: 9)

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 Introduction to Macroeconomics

Growth and GDP

The growth rate of the economy is the rate at which the gross
domestic product (GDP) is increasing.

24
 Introduction to Macroeconomics

How does GDP grow over time?

• Available Resources Change over Time

• Capital and Labour

• Efficiency – Productivity

25
 Introduction to Macroeconomics

Business Cycles

Business Cycles

Peak Recession
GDP (80-81 prices)

Recovery

Trough
1975 1976 1977 1978 1979 1980 1981 1982

26
 Introduction to Macroeconomics

Business Cycles
• The business cycle is the more or less regular pattern of
expansion (recovery) and contraction (recession) in economic
activity around the path of trend growth.

• The trend path of GDP is the hypothesized path GDP would

take if factors of production were fully employed.

• The output gap measures the gap between actual output and the
output the economy could produce at full employment given the
existing resources. Full- employment output is also called
potential output.

• Output gap ≡ actual output − potential output

27
 Introduction to Macroeconomics

Recession
In common usage, a “recession” is a time when the economy is
in generally lousy shape

A recession is a period between a peak and a trough, and an

expansion is a period between a trough and a peak.

A common rule of thumb is that a recession occurs when a

country's real gross domestic product (GDP) declines for two
consecutive quarters.

Who Calls Recessions?

28
 Introduction to Macroeconomics

Importance of Learning Macroeconomics

• For Individuals

• For Business

• For Government

29
 Title of the Presentation

Conclusion

• Three Models of Macroeconomic analysis

• Different Macroeconomic Variables and the

interrelationship

30
 Thank You

Rayees Ahmad Sheikh

Contact Details: Office – J-211
Email: [email protected]
Macroeconomics
Measuring Economy

Rayees Ahmad Sheikh

30-09-2024
 Title of the Presentation

Agenda

• Measuring GDP/National Income

• Three Methods of Measuring GDP

•Problems in Measuring National Income

• Two Important Identities

33
 Introduction to Macroeconomics

Course Outline
Introduction Measuring Economy

Economy in Short Run

Stabilisation Policies
Goods Money IS-LM
Monetary Policy
Market Market Model
Fiscal Policy
Economy in Long Run Run
Aggregate Demand and Supply Phillips Curve

Open Economy in Short and Long Run

Extensions of IS-LM in Extensions of IS-LM in International Adjustments and

Mobility of Goods Mobility of Capital Interdependence

Budget, Public Debt, and Inflation

34
 Measuring Economy

Gross Domestic Product (GDP)

•GDP is a measure of Output of an economy

•GDP is the value of all final goods and services produced

in within a given period.

Note: GDP includes only current production and so does

not count the resale of items.

35
 Measuring Economy

Three methods of measuring GDP

• Production Method: Measure the value-added (sale price

less cost of raw materials) summed across all firms

• Income Method: Labour income (wages/salary) + Capital

Income (interest, dividends) + Land income (rent) +
Entrepreneur’s income (Profit) + Government Income
(taxes)

• Expenditure Method: Spending by consumers (C) +

Spending by businesses (I) + Spending by govt (G) +
Spending by foreign sector (NX)
36
 Measuring Economy

Production Method

Add up value of all output in the economy,

P1Q1 + P2Q2 + ……………. + PnQn

In other words, market value of all final goods and

services produced within economy in a given year.

Catch to definition : How do we know whether a good is

a final good or an intermediate good?

37
 Measuring Economy

Income Method

Labour income (wages/salary)

Capital income (interest, dividend)
Land income (rent)
Entrepreneur’s income (profit)
Government income (taxes)

GDP = Labor inc + Capital inc + Land inc + Entre inc +

Taxes

38
 Measuring Economy

Expenditure Method
Output is made up of four components:

•Consumption spending by households (C)

•Investment spending by firms (I)

•Government spending (G)

•Foreign demand for our net exports (NX)

Y = C + I + G + (X – M)
39
 Measuring Economy

Consumption (C)

• Consumption = purchases of goods and services by the

household (individuals) sector

•includes durables (ex. Cars/ACs/)

•non-durables (ex. Food)
•services (ex. Haircut, Tourism)

Doesn’t include Housing

40
 Measuring Economy

Consumption as % share of GDP in India

41
 Measuring Economy

Investment (I)

Sum of durables, non-durables and services purchased

domestically by BUSINESSES

Business & Residential structures, Capital equipment

and Inventory Investment

What is not : Land & Stocks purchase

42
 Measuring Economy

India : Investment (GFCF) as a % of GDP

43
 Measuring Economy

Government (G)
• Government purchases of goods and services include items
such as national defense expenditures, costs of road paving by
state and local governments, and salaries of government
employees

•Government also makes transfer payments = payments made

to people without their providing a current service in exchange
Ex. Social security, unemployment benefits

•Transfer payments are NOT included in GDP since not a part

of current production

44
 Measuring Economy

India – Government Spending % of GDP

45
 Measuring Economy

Net Exports (NX)

• Accounts for domestic purchases of foreign goods

(imports) and foreign purchases of domestic
• goods (exports) >> NX = Exports – Imports

•Subtract imports from GDP since accounting for

domestic production

•NX can be >, <, or = 0

46
 Measuring Economy

Export India – % of GDP

47
 Measuring Economy

Imports India – % of GDP

48
 Measuring Economy

Gross National Product

• Gross national product (GNP) is an estimate of the total

value of all the final products and services turned out in a
given period by the means of production owned by a
country's residents.

• GNP = GDP +/- NFIFA

•Net Factor Income from abroad

49
 Measuring Economy

Goss Vs. Net Domestic Product

•GDP is the value of a country's total output of goods

and services

•Net domestic product (NDP) is equal to GDP minus

depreciation.
- Capital wears out, or depreciates, while it is being used
to produce output.

50
 Measuring Economy

Real Vs. Nominal GDP

•Real GDP is the value of a country's total output of

goods and services adjusted for inflation or deflation.

•Nominal GDP is given in current prices, without

adjustment for inflation.

51
 Measuring Economy

Food for Thought

52
 Measuring Economy

Per Capita GDP

• Gross Domestic Product (GDP) per capita shows a

country's GDP divided by its total population.

53
 Measuring Economy

Food for Thought

54
 Measuring Economy

Per Capita GDP

55
 Measuring Economy

PPP –Purchasing Power Parity

• PPP is price relatives, which show the ratio of the

prices in national currencies of the same good or service
in different countries.

56
 Measuring Economy

Burgernomics

The Economist Big Mac Index is a comparative tool that

facilitates the comparison of the purchasing power parity
between two countries using the price of a McDonald's
Big Mac burger in the respective countries in their legal
tender.

57
 Measuring Economy

Burgernomics

58
 Measuring Economy

Problems of GDP Measurement

•There are major criticisms of the GDP measure:

•Omits non-market goods and services

•Ex. Work of stay-at-home mothers and fathers not included

in GDP

•No accounting for “bads” such as crime and pollution

•Despite these drawbacks, GDP is still considered one of the

best economic indicators

59
 Measuring Economy

GDP Measurement

• Place each of the following transactions in one of the

four components of expenditures: consumption,
investment, government purchases, and net exports.

a. Tata sells a Safari to the Indian Army.

b. Tata sells a Safari to Reliance Industries.
c. Tata sells a Safari to Japanese Person.
d. Tata sells a Safari to a Indian person.
e. Tata makes a Safari to be sold next year.

60
 Measuring Economy

GDP Measurement
•Patidar Farms
> Wages paid to employees = Rs. 15,000
> Taxes paid to government = Rs. 5,000
>Revenue received from sale = Rs. 35,000
>Potatoes sold to public = Rs. 10,000
> Potatoes sold to Balaji Wafers = Rs. 25,000

• Balaji Wafers
Wages paid to employees = Rs. 10,000
Taxes paid = Rs. 2,000
Potatoes purchased from Patidar Farms = Rs. 25,000
Revenue received from sale = Rs. 40,000
61
 Measuring Economy

GDP Measurement
Production Method:
Value added
= (Sales – Intermediate goods)PF + (Sales – Intermediate
goods)Balaji
= Rs. 35,000 + Rs. (40,000 – 25,000)
= Rs. 50,000

Income Method:
Cost
= (Wages + Profits + Taxes)pf + (Wages + Profits +
Taxes)Balaji
= Rs. (15,000 + 15,000 + 5,000) + Rs. (10,000 + 2,000 + 3,000)
= Rs. 50,000

62
 Measuring Economy

GDP Measurement

Expenditure Method:
Y = C + I + G + (X – M)
= C1 + C2
= Rs. 10,000 + Rs. 40,000
= Rs. 50,000

63
 Measuring Economy

Saving and Income Identity

Closed economy with no Government & external sector

Y C+I
Households can do only two things income: Consume and
Save
Y =C+S

C
+I  Y  C
+S
demand income

I Y −C  S
64
 Measuring Economy

Adding G and NX
• Add government and the foreign sector
YD = Y + TR -TA
• Disposable (after-tax) income, YD, is what consumers split between C
and S
YD = C + S

YD – TR + TA = C + I + G + NX

C+ S –TR + TA = C + I + G + NX

S - I = (G + TR –TA) + NX
65
 Measuring Economy

Some Identities: Adding G and NX

S − I  (G + TR − TA) + NX
14444444244444443 {
TradeSurplus
BudgetDeficit

• Excess of savings over investment (S > I) in the private sector

is equal to the government budget deficit plus the trade
surplus

• Any sector that spends more than it receives in income has to

borrow to pay for the excess spending

Private sector can dispose of savings in three ways:

1. Make loans to the government
2. Private sector can lend to foreigners
3. Private sector can lend to firms who use the funds for I 66
 Measuring Economy

Understanding Identities – In figures

67
 Measuring Economy

Inflation and Prices

• Price Indexes measure the cost of a fixed ‘basket’ of goods over
time

• Inflation rate = % change in P, where P is the general price level

Inflation = [P(t+1) - P(t)] / P(t)

• Prominent Price Indices

GDP Deflator
Value of Current Output at Current Prices / Value of Current
Output at Base Year Prices

CPI (Consumer Price Index) and WPI (Wholesale Price Index)

68
 Measuring Economy

Measures of Inflation

• GDP Deflator is the only measure of inflation that

takes into account the inflation in all the good and services
produced in the economy.

• Consumer Price Index is a weighted sum of prices of a

standard basket of goods and services consumed by a
typical domestic consumer.

•WPI measures overall change in producer prices over

time.
69
 Measuring Economy

CPI vs. WPI

Wholesale Price Index Consumer Price Index
Index available on weekly basis with short Index constructed on a monthly basis
time lag of 2 weeks with lag of 1 month
Base year is 2012; earlier 04-05 Base year is 2012; 2016

Primary Products 22.02 Food 46.19

Food Articles 15.40 Pan, Supari, Tobacco
Minerals 0.49 & Intoxicants 2.27
Fuel Group 14.23 Fuel & light 6.43
Coal Mining 1.75
Electricity 5.48
Manufactured Products 63.75 Housing 15.27
Food Products 11.54 Clothing, Bedding &
Textiles 9.80 footwear 6.58
Chemicals 11.93 Miscellaneous 23.26
Basic Metals 8.34
Machinery & machine tools 8.36
70
 Measuring Economy

Unemployment

• Frictional Unemployment

• Structural Unemployment

• Cyclical Unemployment

• Seasonal Unemployment

71
Data Sources in India
• Government of India, Ministry of Statistics and
programme Implementation Web site: http://mospi.gov.in/

•CSO: The Central Statistical Organisation is responsible for

coordination of statistical activities in the country, and evolving and
maintaining statistical standards.
•Data: National Income Accounts, CPI, WPI etc.

•NSSO- The National Sample Survey (NSS), initiated in the year

1950, is a nation-wide, large-scale, continuous survey operation
conducted in the form of successive rounds. Surveys on
consumption, employment

•RBI - https://cimsdbie.rbi.org.in/#/dbie/home
72
Take Home Question
1. Consider Following Information:
GDP 6000
Gross Investment 800
Net Investment 200
Consumption 4000
Government Purchases 1100
Government Budget 30
Surplus
Find:
a. NDP
b. Next Exports
c. Disposable Personal Income
d. Personal Savings
e. Government taxes minus transfers
73
Thank You
Macroeconomics
The Goods Market

Rayees Ahmad Sheikh

01/10/2024
Take Home Question
1. Consider Following Information:
GDP 6000
Gross Investment 800
Net Investment 200
Consumption 4000
Government Purchases 1100
Government Budget 30
Surplus
Find:
a. NDP
b. Next Exports
c. Disposable Personal Income
d. Personal Savings
e. Government taxes minus transfers
76
Take Home Question
•NDP
- Depreciation = I g - I n = 800 - 200 = 600
- NDP = GDP – Depreciation
- 6000 - 600 = 5400

•Next Exports
- GDP = C + I + G + NX
- NX = GDP - C – I – G
- NX = 6000 - 4000 - 800 - 1100 = 100

77
Take Home Question
•Government taxes minus transfers
BS = TA - G – TR
30 = TA – 1100 – TR
TA –TR = 1130

•Disposable Personal Income

YD = Y + TR –TA
YD = Y – (TA-TR)
YD = 6000 – 1130 = 4870

78
Take Home Question
•Personal Savings
YD = C + S
4870 = 4000 + S
S = 870

79
 Introduction to Macroeconomics

Course Outline
Introduction Measuring Economy

Economy in Short Run

Stabilisation Policies
Goods Money IS-LM
Monetary Policy
Market Market Model
Fiscal Policy
Economy in Long Run Run
Aggregate Demand and Supply Phillips Curve

Open Economy in Short and Long Run

Extensions of IS-LM in Extensions of IS-LM in International Adjustments and

Mobility of Goods Mobility of Capital Interdependence

Budget, Public Debt, and Inflation

80
 The Goods Market

Agenda

• Understand National Income Determination

• Consumption and Investment Equivalence

81
 The Goods Market

Introduction

Source: https://www.khanacademy.org/ 82
 The Goods Market

Introduction
• Output fluctuates around the potential output level

• Business cycles - cyclical periods of boom and recession

•There is a relationship between output, Income and

spending

• Spending determines Output & Income

• Output & Income determine Spending

83
 The Goods Market

Introduction

• We assume prices are constant

• Firms are willing to sell anything at given price levels

• How will the aggregate supply curve look like?

• Given assumption about AS

---- our job is to understand Aggregate Demand

84
 The Goods Market

Aggregate Demand and Equilibrium Output

• Aggregate Demand – “total amount of goods and services
demanded in economy”

AD = C + I + G + NX

• At equilibrium level

Y = AD = C + I + G + NX

• When there is difference between Y and AD ….What

happens?

•Share of Consumption Demand in GDP?

85
 The Goods Market

Consumption Function

• “relationship between consumption and income”

• higher the income higher is the consumption

- households as well as countries
C = 𝐶ҧ + cY

where 𝐶ҧ > 0 and 0 < c < 1

86
 The Goods Market

Consumption Function

• 𝐶ҧ is the part of Consumption when income is “zero”

• c is the change in consumption with increase in income

• c is popularly known as?

• Marginal Propensity Consume

87
 The Goods Market

The Consumption Function and Aggregate Demand

88
 The Goods Market

Consumption and Savings

If C = 1510 + 0.95Y, what will be the saving function?

89
 The Goods Market

Consumption and Savings

• What happens to portion of income remaining after

consumption?
- it is saved
S≡Y–C
The equation above represents Budget Constraint

S = Y – C = Y – (𝐶ҧ + cY)

S = - 𝐶ҧ + (1-c)Y

90
 The Goods Market

Consumption and Savings

• 1-c is marginal propensity to save (MPS)

• Can be represented by “s”

• If mpc is 0.5 what is the marginal propensity to save?

91
 The Goods Market

Consumption, AD and Autonomous Spending

• YD = Y – TA + TR

• C = 𝐶ҧ + cYD = 𝐶ҧ + c (Y + TR –TA)

• AD = C + I + G + NX
= 𝐶ҧ + c (Y - 𝑇𝐴 +𝑇𝑅 ) + 𝐼 ҧ + 𝐺ҧ + 𝑁𝑋
= [𝐶ҧ - c (𝑇𝐴 +𝑇𝑅 ) + 𝐼 ҧ + 𝐺ҧ + 𝑁𝑋 ] + cY

= 𝐴ҧ + cY
92
 The Goods Market

Equilibrium Income and Output

• At equilibrium Y = AD

• Y = 𝐴ҧ + cY

1 ҧ
• 𝑌𝑜 = 1−𝑐 𝐴

1 ҧ
• ∆Y= 1−𝑐 ∆𝐴

93
 The Goods Market

Equilibrium Income and Output

• What does higher marginal propensity to

consume imply?

• What does higher the level of autonomous

spending 𝐴ҧ imply?

1 ҧ
𝑌𝑜 = 1−𝑐 𝐴

• Steep Curve and Larger Intercept

94
 The Goods Market

Determination of Equilibrium Income and Output

95
 The Goods Market

Multiplier

• The Multiplier is the amount by which equilibrium

output changes when autonomous aggregate demand
increases by one unit.

96
 The Goods Market

Multiplier in Practice
• Size of Multiplier?

• Larger the increase in autonomous spending >> the larger

the income change

• larger the marginal propensity to consume—that is, the

steeper the aggregate demand schedule—the larger the
income change.

• https://youtu.be/W4lXJyNKuQs

97
 The Goods Market

Multiplier in Picture

98
 The Goods Market

Multiplier in Practice

• Robert Hall found that in practice the multiplier is

around 1.7

• Valerie Ramey of the University of California, San

Diego, puts the estimate in the range of 0.8 to 1.5

99
 The Goods Market

Practice Question

• In a model with no government or foreign sector, if

saving is defined as C = 100 + (0.8)Y and investment is I
= 50.

•What is the equilibrium level of savings?

100
 The Goods Market

Take HOME Question

• Suppose the consumption is given as C = 100 + .9Y,

while I is 50.

• What is the equilibrium level of income?

• What is the value of the multiplier?

101
Thank You

Rayees Ahmad Sheikh

[email protected]
Macroeconomics
Goods Market

Rayees Ahmad Sheikh

08/10/24
 The Goods Market

Agenda

•Determinants of National Income

•Role of Government

•Multiplier

104
 The Goods Market

Introduction

• In short run assume that prices are constant

• Firms are willing to sell anything at given price levels

105
 The Goods Market

Government Sector

• In recession people expect and demand that the

government do something about it

• What can the government do with respect to aggregate

demand?

- purchases of goods and services, G

- Taxes and Transfer

106
 The Goods Market

Government Sector

• Fiscal policy is the policy of the government with regard

to the

level of government purchases

the level of transfers

the tax structure.

107
 The Goods Market

Tax
ҧ and so is the level
• Let us assume G is constant “𝐺”
of transfers “𝑇𝑅” and proportional income tax

• 𝑇𝐴 = tY
“t” being tax rate

• C = 𝐶ҧ + c(Y + 𝑇𝑅 - tY)

= 𝐶ҧ + c 𝑇𝑅 + c(1-t)Y

108
 The Goods Market

Tax

• AD = C + I + G + NX

= [𝐶ҧ + c 𝑇𝑅 + c(1-t)Y ] + 𝐼 ҧ + 𝐺ҧ + 𝑁𝑋

= [𝐶ҧ + c 𝑇𝑅 + 𝐼 ҧ + 𝐺ҧ + 𝑁𝑋 ] + c(1-t)Y

= 𝐴ҧ + c(1-t) Y

Where 𝐴ҧ = 𝐶ҧ + c 𝑇𝑅 + 𝐼 ҧ + 𝐺ҧ + 𝑁𝑋
109
 The Goods Market

Equilibrium Income

Y= 𝐴ҧ + c(1-t) Y

1 ഥ𝐴
𝑌𝑜 = 1−𝑐(1−𝑡)

What will be the impact of tax on Multiplier?

Income Tax acts as Automatic Stabilizers

110
 The Goods Market

Effects of a Change in Fiscal Policy

• increase in government purchases is a change in

autonomous spending
∆Y = ∆𝐺ҧ + c(1-t) ∆Y

1 ҧ
∆Y= 1−𝑐(1−𝑡) ∆ 𝐺 = 𝛼𝐺 ∆𝐺ҧ

1
𝛼𝐺 =
1−𝑐(1−𝑡)

111
 The Goods Market

Effects of a Change in Fiscal Policy

112
 The Goods Market

Changes in government spending and taxes affect

• During Recession?

• During Boom?

113
 The Goods Market

Budget Deficit

Source: Trading Economics.com 114

 The Goods Market

Budget Deficit/Surplus

•the excess of the government’s revenues, taxes, over its

total expenditures, consisting of purchases of goods and
services and transfer payments.
BS ≡ TA − G − TR

BD(S) = TA - 𝐺ҧ - 𝑇𝑅

BD(S) = t(Y) - 𝐺ҧ - 𝑇𝑅

• Effect of G and t on Budget Surplus?

115
 The Goods Market

Budget Deficit/Surplus

116
 The Goods Market

Take Home Exam

Suppose
ഥ = 200 ; 𝑻𝑹 = 200 ; t = .20
C = 50 + .8 YD ; ത𝑰 = 70 ; 𝑮

a.) Calculate the equilibrium level of income and the

multiplier?

b.) Calculate budget surplus ?

c.) Calculate the change in the budget surplus. Would you

expect the change in the surplus to be more or less if c = .9
rather than .8?
117
Thank You
Macroeconomics
IS Curve

Rayees Ahmad Sheikh

Date: 08/10/24
 Equilibrium in Goods Market

Agenda

• Linkage Between Goods and Money Market

• Equilibrium in Goods Market

• Deriving IS Curve?

• Slope of IS Curve

• Shift in IS Curve

120
 Equilibrium in Goods Market

Introduction

• Determinants of National Income

• AD = C + I + G + NX

• Y = AD = C + I + G + NX

- What happens to AD when C changes?

- Fiscal Policy and Change in AD
- G changes , Tax Change & Transfers Change

121
 Equilibrium in Goods Market

Four Type of Markets in Macroeconomics

• Goods Market

• Money Market

• Bond Market

• Factor Market

122
 Equilibrium in Goods Market

Introduction

•The goods market interacts with money market through

- investment demand

• “interest rate”

123
 Equilibrium in Goods Market

Introduction

124
 Equilibrium in Goods Market

IS Curve

• IS curve—that shows combinations of interest rates and

levels of income at which the goods markets clear.

• I stands for Investment

• S stands for Savings

- The IS curve is derived in two steps.

- investment depends on interest rates
- investment demand and aggregate demand
125
 Equilibrium in Goods Market

Investment Demand Schedule

• There is inverse relationship between investment and

interest rate.

• firms will want to borrow and invest more when interest

rates are lower.

126
 Equilibrium in Goods Market

Investment And The Interest Rate

I = 𝐼 ҧ + bi
Where 𝐼 ҧ denotes autonomous investment spending, “i” is
interest rate and b is measures the responsiveness

127
 Equilibrium in Goods Market

Introduction

128
 Equilibrium in Goods Market

The Interest Rate and Aggregate Demand: The IS Curve

• AD = C + I + G + NX

= [ 𝐶ҧ + c𝑇𝑅+ c(1-t)Y] + (𝐼 ҧ + 𝑏𝑖) + 𝐺ҧ + 𝑁𝑋

= 𝐴ҧ + c(1-t)Y - bi

129
 Equilibrium in Goods Market

IS Curve

130
 Equilibrium in Goods Market

IS Curve

131
 Equilibrium in Goods Market

Deriving IS curve from goods market equilibrium

• IS curve is called the goods market equilibrium schedule.

• Y = AD = 𝐴ҧ + c(1-t)Y

• Y = AD = 𝐴ҧ + c(1-t)Y - bi

• Y = 𝛼𝐺 (𝐴ҧ − bi)

1
𝛼𝐺 =
1−c(1−t)

132
 Equilibrium in Goods Market

The Slope of the IS Curve

• “b” we have talked so far- “Negative Slope”

• How will the slope impact?

• Recall the sessions from Microeconomics about

“elasticity”

“steepness of the curve”

133
 Equilibrium in Goods Market

The Role of the Multiplier- steepness of the IS curve

134
 Equilibrium in Goods Market

The Role of the Multiplier- steepness of the IS curve

135
 Equilibrium in Goods Market

The Role of the Multiplier- steepness of the IS curve

• “the smaller the sensitivity of investment spending to

the interest rate and the smaller the multiplier, the steeper
the IS curve.”

𝐴ҧ 𝑌
i= −
𝑏 𝛼𝐺 𝑏

136
 Equilibrium in Goods Market

Position of IS Curve or Shift in IS Curve

137
 Equilibrium in Goods Market

Position of IS Curve or Shift in IS Curve

138
 Equilibrium in Goods Market

Conclusion
• IS curve is the schedule of combinations of the interest
rate and level of income such that the goods market is in
equilibrium.

• IS curve is negatively sloped

• smaller the multiplier and the less sensitive investment

spending

• IS curve is shifted by changes in autonomous spending

139
Thank You
Macroeconomics
Demand for Money

Rayees Ahmad Sheikh

05-11-2024
 Introduction to Macroeconomics

Course Outline
Introduction Measuring Economy

Economy in Short Run

Stabilisation Policies
Goods Money IS-LM
Monetary Policy
Market Market Model
Fiscal Policy
Economy in Long Run Run
Aggregate Demand and Supply Phillips Curve

Open Economy in Short and Long Run

Extensions of IS-LM in Extensions of IS-LM in International Adjustments and

Mobility of Goods Mobility of Capital Interdependence

Budget, Public Debt, and Inflation

142
 Demand for Money

Agenda

• What is Money?

• Functions of Money

• Demand for Money

• Why Households/Firms demand and hold money?

143
 Demand for Money

Introduction

https://youtu.be/yPGXj4e8imE

144
 Demand for Money

Money

• Usual meaning of money “means of payment or the

medium of exchange”

• Colloquial use, “money” sometimes means “income”

• “The person has lot of money” “Paisa Wala”

• but economists have a technical meaning of money

145
 Demand for Money

Money
• “The stock of assets held as cash, checking accounts, and
closely related assets, specifically not generic wealth or
income.”

• Why is it important?

•“Why consumers and firms hold money as opposed to an

asset with a higher rate of return.”

• Interaction between the demand for money and the supply of

money affects prices and output.

146
 Demand for Money

Money

• There is a vast array of financial assets in any economy,

from currency to complicated claims on other financial
assets. Which part of these assets is called money?

“Where to draw the line between assets that form part of

our definition of money and those that are just financial
assets and not money?”

147
 Demand for Money

Money Statistics in India

• Second Working Group on Money Supply (SWG) in 1977, RBI has
been publishing four monetary aggregates – M1, M2, M3 and M4

• M1 and M3 are extensively used both for policy purposes and in

academic exercises.

• M1 includes currency with the public, non-interest bearing

deposits with the banking sector including that of RBI

•M3 captures the complete balance sheet of the banking sector.

•M2 and M4 that include post office savings banks deposits are not
very widely used.
148
 Demand for Money

Money Statistics in India

• Reserve Money (M0): Other names include High-Powered
Money, Financial Base, Base Money, etc. M0 is calculated as
follows: Money in circulation + Bankers’ deposits + Other
deposits with RBI.
•Narrow Money (M1): M1 equals money in circulation plus
demand deposits in the banking system (current and savings
accounts) plus additional deposits with the Reserve Bank of
India (RBI).
•Narrow Money (M2): Post Office Savings, Bank Savings
Deposits added to M1 equals M2.
•Broad Money (M3): M3 equals M1 plus time deposits made
with banks.
•Broad Money (M4): M4 is equal to M3 plus any deposits
made at post office savings banks.
149
 Demand for Money

Money Statistics in India

• M0= Currency in Circulation + Bankers’ Deposits with

RBI + ‘Other’ Deposits with RBI* (Weekly Compilation)
• M1 = Currency with the Public + Demand Deposits with the
Banking System + ‘Other’ Deposits with RBI*
• M2=M1+ Time Liabilities Portion of Savings Deposits with
the Banking System + Certificates of Deposit issued by Banks
+ Term Deposits of residents with a contractual maturity of
up to and including one year with the Banking System
• M3=M2+ Term Deposits of residents with a contractual
maturity of over one year with the Banking System +
Call/Term borrowings from ‘Non-depository’ financial
corporations by the Banking System.
150
 Demand for Money

Money and Liquidity

• M1 comprises those claims that are liquid

• An asset is liquid if it can immediately, conveniently, and

cheaply be used for making payments.

• M1 is also called narrow concept of Money whereas M3 is

called broad concept of Money.

• As we move from M1 to M4 the liquidity of asset falls where

as yield increases.

•Tradeoff between yield and liquidity

151
 Demand for Money

Financial Innovation
• UPI

• Credit Cards

• INR 2000 now pulled out of circulation

•ATM

•Phone Banking

• What about Crypto?

152
 Demand for Money

Functions of Money
• Medium of exchange

• A store of value

• The unit of account

• Standard of deferred payment

“Money is accepted in payment only because of the belief

that it will later also be accepted in payment by others.”

153
 Demand for Money

Currency in Circulation in India

• Currency in Circulation stands Rs 34.70 lakh crore, as of

September 6, 2024.

• Who Holds this Money?

• Purpose of holding money ?

154
 Demand for Money

Currency in Circulation in India

•Rupees Notes held outside India? If there are any?

•Rupee Notes produced outside India or within India not

by RBI (Counterfeiting)

•Currency Held in Illegal Economy and Shadow Economy

(Drug Dealers etc.)

•What did “note bandi” in India do?

155
 Demand for Money

Demand for Money

• The demand for money is a demand for real balances.

• people hold money for its purchasing power

“Money Illusion”

• An individual is free from money illusion if a change in

the level of prices, holding all real variables constant,
leaves the person’s real behavior, including real money
demand, unchanged.

156
 Demand for Money

Keynes’s three motives for holding money

• The Transaction Motive

• The Precautionary motive

• The Speculative motive

• M1 mostly relevant got Transaction and Precautionary

• M3 relevant for Speculative motive

157
 Demand for Money

Basis of Keynesian Theory

• A tradeoff between the benefits of holding more money

versus the interest costs of doing so.

• The interest rate on money is referred to as the own rate

of interest, and the opportunity cost of holding money is
equal to the difference between the yield on other assets
and the own rate.

158
 Demand for Money

The Transactions motive

• Exact instant you need to make a payment

• Tradeoff here is between the amount of interest an individual

forgoes by holding money and the costs and inconveniences of
holding a small amount of money.

•The greater the number of trips to the bank, the larger the
amount earning interest in the savings account.

•Baumol-Tobin formula for the demand for money

𝑀 𝑡𝑐 𝑋 𝑌
=
𝑃 2𝑖

159
 Demand for Money

The Precautionary Motive

• Uncertainty

• Risk & Uncertainty? How are they different?

• Individual does not know precisely what payments they will

be receiving in the next few weeks and what payments will
have to be made.

• A sudden craving for pizza

•A Cab back to Campus from Vijaynagar

160
 Demand for Money

The Precautionary Motive

• Technology and the structure of the financial system are

important determinants of precautionary demand.

• During times of danger/War families may keep hidden

hordes of cash
- Money in Rice Bins by Grandma

• Credit cards, debit cards, and smart cards reduce

precautionary demand.

161
 Demand for Money

The Speculative Demand For Money

• Investor would want to hold the asset that provides the
highest returns.

• Return on most assets is uncertain

• Investing entire sum in risky assets is unwise

• Money is a safe asset in that its nominal value is known with

certainty.

• An increase in the expected return on other assets—an

increase in the opportunity cost of holding money

162
 Demand for Money

The Speculative Demand For Money

• “Risk Aversion”

• Risk associated with “savings account”

• Mutual Funds

• Bonds

• Equity

163
 Demand for Money

The Income Velocity of Money

• demand for money is negatively related to the interest rate.

• income elasticity of money demand

• What will happen to demand for money when income increases?

• demand for money adjustment to change in income usually

happens with a lag … Why?

•there are costs of adjusting money holdings

• money holders’ expectations are slow to adjust

164
 Demand for Money

The Income Velocity of Money

• What is velocity?

• “income velocity of money is the number of times the

stock of money is turned over per year in financing the
annual flow of income”

• It is equal to the ratio of nominal GDP to the nominal

money stock.
𝑃×𝑌 𝑌
𝑉 ≡ = 𝑀ൗ
𝑀 𝑃

165
 Demand for Money

The Income Velocity of Money

• The demand for money can be easily adjudged from money
velocity function

𝑀Τ =L(i,Y)
𝑃

𝑌
𝑉=
L(i,Y)

L ( i , Y ) = Y × l( i )

high velocity means low money demand.

166
 Demand for Money

The Quantity Theory

• Relationship between money, prices, and output:

M× 𝑉 =𝑃 × 𝑌

•Assuming, Economy is at full employment and V is

constant .

•Price level is proportional to the money stock.

167
 Demand for Money

To Conclude
• The demand for money is a demand for real balances.

• Narrow and Broad Concept of Money- M1 and M3

• Decisions to hold money are based on a tradeoff between

the liquidity and yield

•negative interest elasticity of money demand and a positive

income elasticity.

•income velocity of money

168
 Thank You

Rayees Ahmad Sheikh

Contact Details: [email protected]
Macroeconomics
Central Bank and Money Supply

Rayees Ahmad Sheikh

11/11/24
 Introduction to Macroeconomics

Course Outline
Introduction Measuring Economy

Economy in Short Run

Stabilisation Policies
Goods Money IS-LM
Monetary Policy
Market Market Model
Fiscal Policy
Economy in Long Run Run
Aggregate Demand and Supply Phillips Curve

Open Economy in Short and Long Run

Extensions of IS-LM in Extensions of IS-LM in International Adjustments and

Mobility of Goods Mobility of Capital Interdependence

Budget, Public Debt, and Inflation

171
 Money Supply

Ideal Financial Minister of India

https://www.youtube.com/shorts/pzj-
iLY3irs?feature=share

172
 Money Supply

Managing Money Supply

• Central Bank – Reserve Bank of India

• Monetary Policy

173
 Money Supply

Reserve Bank of India

•Reserve Bank of India was constituted through RBI Act,

1934

• Initially headquartered in Kolkata shifted to Mumbai in

1937

• RBI was initially privately owned but since

nationalization in 1949 is wholly owned by the
Government of India.

174
 Money Supply

Reserve Bank of India

• Central board consists of 5 official directors (Governor and four
deputy governors)

• 15 non-official directors. One of them represents the central

government.

• Ten others with expertise in different fields such as in economics, law,

and business are nominated by the central government.

• The remaining four members are also nominated by the central

government and represent the local boards.

• There are four local boards in Chennai, Kolkata, Mumbai, and New
Delhi and these represent regional and economic interests.
175
 Money Supply

Objectives of RBI

• Price Stability

• Financial Stability

• Economic Growth

• Exchange Rate Stability

176
 Money Supply

Functions of RBI

• Monetary Policy

• Lender of last resort

• Supervising and Regulating Banking Institutions

• Financial Services to Banks and Government

177
 Money Supply

Monetary Policy Instruments in India

• Open Market Operations

• Discount Rate (Bank Rate)

• Reserve Requirements

- the extent and the nature of use of these instruments

have changed over time

178
 Money Supply

Reserve Requirement
• Cash Reserve Ratio

- Current CRR in India is 4.5%.

• Statutory Liquidity Ratio

- Current SLR in India is 18%

179
 Money Supply

Reserve Requirement

180
 Money Supply

Open Market Operation

• Buying and Selling of Government Securities

• How does RBI decide to Buy or Sell?

• Buying Securities will Pump the cash in Circulation

• Selling Securities will Suck the cash in Circulation

181
 Money Supply

Bank Rate

The Bank Rate primarily deals with long-term loans and

overall economic stability.
- No collateral.

Repo Rate focuses on short-term liquidity and immediate

monetary conditions.

- Government securities as collateral.

MSF- Marginal Standing Faciality

It is a window for banks to borrow from the Reserve Bank of
India in an emergency when inter-bank liquidity dries up
completely.
182
 Money Supply

Repo Rate

Repo/Reverse repo is a repurchase agreement in which

both parties agree to sell and repurchase a security on an
agreed date at a predetermined price.

When RBI buys Securities?

When RBI sells Securities?

183
 Money Supply

Repo Rate

When RBI buys government securities from RBI to give

funds, repo rate is applicable.

When RBI sells government securities to Banks to park

funds reverse repo is applicable.

184
 Money Supply

Repo Rate

185
 Money Supply

Monetary Transmission Mechanism

• Change in Monetary Policy

- Change in Interest Rate
- impacts Investment, Consumption
- effect on Aggregate Demand
- effect on Quantity and Price (Output)

186
 Money Supply

Problems with Managing Money Supply

• No Control over Household Savings

• No Control of, how much Banks Lend

187
Thank You

Rayees Ahmad Sheikh

[email protected]
 Macroeconomics
Money Stock Determination and Money
Multiplier

Rayees Ahmad Sheikh

11/11/24
 Introduction to Macroeconomics

Course Outline
Introduction Measuring Economy

Economy in Short Run

Stabilisation Policies
Goods Money IS-LM
Monetary Policy
Market Market Model
Fiscal Policy
Economy in Long Run Run
Aggregate Demand and Supply Phillips Curve

Open Economy in Short and Long Run

Extensions of IS-LM in Extensions of IS-LM in International Adjustments and

Mobility of Goods Mobility of Capital Interdependence

Budget, Public Debt, and Inflation

190
 Money Stock Determination and Money Multiplier

Agenda

• Monetary Base

• Money Multiplier

• Determination of Money Supply

• Role of different instruments of Monetary Control

191
 Money Supply

Supply of Money

https://youtu.be/lK_rYS8L3kI

192
 Money Stock Determination and Money Multiplier

Repo Rate in India

193
 Money Stock Determination and Money Multiplier

Three Key Players in Money Supply

• Central Bank – Reserve Bank of India

• Commercial Banks: Financial Intermediaries

• Households: Depositors include households and

institutions

194
 Money Stock Determination and Money Multiplier

Money Supply
• The money supply (or money stock): the quantity of money
available in the economy

• Currency

- held by public

• Deposits

• fractional reserve banking

• The real money supply is determined by a blend of two fictional

systems “base” and “deposits”.

195
 Money Stock Determination and Money Multiplier

Monetary Base

• Monetary Base (H) = Currency in Circulation (C) +

Reserves (R) (Banks’ deposits at the RBI)

It is also called High-Powered Money

Fed’s (RBI) control over the monetary base is the main

route through which it determines the money supply.

196
 Money Stock Determination and Money Multiplier

Monetary Stock
• RBI has direct control over high-powered money, H.

• We are interested in the supply of money, M.

• The two are linked through mm money multiplier.

• Money Stock = Currency ( C ) + Deposits (D)

- What is the relationship between Monetary Base and

Money Stock

197
 Money Stock Determination and Money Multiplier

Relationship Between Monetary Base and Money Stock

198
 Money Stock Determination and Money Multiplier

Money Multiplier
• “mm” Ratio of the stock of Money to the stock of High
Powered Money

• Size of Money Multiplier

>1, or = 1 or <1

• Currency uses a Rupee of H for a Rupee of M

• Deposits use only a fraction of M

- if reserve ratio is 10 % every rupee in M uses only 10 paisa
in H

199
 Money Stock Determination and Money Multiplier

Money Multiplier
• Money Stock M = C + D ---------- 1

• Monetary Base H = C + R ------------- 2

- The behavior of Households, Banks and Central Bank

Households – Cash/Currency or Deposit
Currency Deposit Ratio, cu = C/D
Banks Face Reserve Requirement
Reserve Ratio re = R/D
Central Bank- Controls MB
200
 Money Stock Determination and Money Multiplier

Money Multiplier
• M = (cu + 1)D

• H = (cu + re)D

1+𝑐𝑢
• M= 𝐻
𝑟𝑒+𝑐𝑢

• M = mm × H

1+𝑐𝑢
• mm =
𝑟𝑒+𝑐𝑢

201
 Money Stock Determination and Money Multiplier

Properties of the Multiplier

• Smaller the re higher is the multiplier

• Smaller the cu higher is multiplier

202
 Money Stock Determination and Money Multiplier

Currency Deposit Ratio

• it is mostly determined by the cost of obtaining cash

• strong seasonal pattern – festive season

203
 Money Stock Determination and Money Multiplier

Reserve Ratio

• Reserve Ratio consists of reserves at RBI and Vault

Cash and Coins held by Bank

CRR and SLR

• Do Banks hold something extra than the mandatory

rates?
Why?
What are the forms in which bank keep extra reserves?

204
 Money Stock Determination and Money Multiplier

RBI as Banker to Bankers

• How are Cheques cleared?

• Excess reserves with more cash is required

205
 Money Stock Determination and Money Multiplier

The Instruments of Monetary Control

• Open Market Operations

• Discount Rate

• Reserve Ratio

206
 Money Stock Determination and Money Multiplier

Open Market Operation

• Buying and Selling of Government Securities

• Who buys or sells the Government Securities ?

- RBI, Banks and Individuals?

A case of OPO Purchase by RBI

207
 Money Stock Determination and Money Multiplier

Open Market Operation

• The RBI’s ownership of government securities rises by $1 million

• RBI pay for the bond by writing a check on itself.

• the seller receives a check worth $1 million

• The seller takes the check to bank, which credits the depositor with
the $1 million

• Bank has an account at the Fed the account is credited with $1

million

•“Bank deposits at Fed” entry on the liabilities side of the balance

sheet rises by $1 million.
208
 Money Stock Determination and Money Multiplier

What is the catch in whole exercise?

• Central Bank pays for the purchase of securities by writing a
check

• RBI has power to create money with a stroke of pen

• What happens because of this? The increase in monetary

base

- the Fed can create high-powered money at will merely by

buying assets, such as government bonds, and paying for them
with its own liabilities.

209
 Money Stock Determination and Money Multiplier

What Happens to the Balance Sheet of Central Bank?

Fed buys, say $1 million of government bonds from a private

individual.

210
 Money Stock Determination and Money Multiplier

Balance Sheet of RBI

211
 Money Supply

Supply of Money

https://youtu.be/lK_rYS8L3kI

212
 Money Stock Determination and Money Multiplier

What happens if Banks fall short of Reserves?

• Borrow from Banks with excess reserves

Or

• Borrow from RBI

• The RBI provides high-powered money to banks that

need it temporarily by lending to them at ????
Which rate is applicable?

• Repo Rate, Bank Rate or MSF

213
 Money Stock Determination and Money Multiplier

Reserve Ratio and Interest on Reserves

Since borrowed reserves are also part of high-powered

money, the Fed’s discount rate has some effect on the
monetary base.

Repo Rate vs. Reverse Repo Rate?

214
 Money Stock Determination and Money Multiplier

Financing Federal Deficit

Can finance by selling government bond to the public

Government can finance its deficit by borrowing from the

RBI.

215
 Money Stock Determination and Money Multiplier

Control of Money Stock and Control of

Interest Rate

The Fed cannot simultaneously set both the interest rate

and the stock of money at any given target levels that it
may choose.

In day to day operations it is easy to control interest rate

What happens to price of government securities when

RBI increases or decreases interest rates?

216
 Money Stock Determination and Money Multiplier

Control of Money Stock and Control of

Interest Rate
Controlling interest rate and the stock of money

217
 Money Stock Determination and Money Multiplier

Control of Money Stock and Control of

Interest Rate
• If RBI wants to raise the price of government
securities (lower the interest rate), it can buy the
securities at that price.
• If RBI wants to reduce the price of government
securities (raise the interest rate), it can sell a sufficient
amount of securities from its large portfolio.

218
Thank You

Rayees Ahmad Sheikh

[email protected]
Macroeconomics
LM Curve

Rayees Ahmad Sheikh

12/11/2024
 ISLM Model

Agenda

• Derive LM Curve

• Slop of LM Curve

• Shift in LM Curve

• ISLM Model

• ISLM and Aggregate Demand

221
 ISLM Model

Introduction

• L – M stand for

- Liquidity Preference and Money Supply

• The LM curve shows combinations of interest rates

and levels of output
- such that money demand equals money supply.

222
 ISLM Model

LM Curve
• LM is derived in two steps

• Money Demand (real rather than nominal demand)

- Money Demand Depends on Income and Interest

• Equate money demand with money supply—set by the

central bank
- find the combinations of income and interest rates that
keep the money market in equilibrium

223
 ISLM Model

Demand for Money

• The demand for money is a demand for real money balances
- Why?
- People hold money for what it will buy – purchasing Power
What happens when Price level doubles?

• The demand for real balances depends on the level of real

income and the interest rate.

L = kY - hi where k, h > 0
• L is Money Demand , Y is income , i is interest rate , k & h
are the sensitivity factors

224
 ISLM Model

Demand for Money

225
 ISLM Model

The Supply of Money

• Nominal quantity of money, M, is controlled by the

Central Bank – RBI in India

• Nominal quantity of money = 𝑀 ഥ

• A constant Price Level = 𝑃ത
when, demand for real balances is equal to the money
supply.
ഥ
𝑀
= kY – hi
𝑃
1 ഥ
𝑀
i= kY −
ℎ 𝑃
226
 ISLM Model

Derivation of the LM Curve

227
 ISLM Model

The Slope of the LM Curve

• responsiveness of the demand for money to income
- k

• responsiveness of the demand for money to interest

-h

• higher the value of k and lower the value of h steeper

the LM curve will be.
- Vertical LM Curve , h = tends to 0
- Horizontal LM Curve , h is very high

228
 ISLM Model

The Position of the LM Curve

229
 ISLM Model

Equilibrium in the Goods and Money Markets

230
 ISLM Model

Assumption of the Model

• The major assumption is that the price level is

constant and that firms are willing to supply whatever
amount of output is demanded at that price level.

• assumption is one that is temporarily needed for the

development of the analysis

231
 ISLM Model

Changes in the Equilibrium Levels of Income and the

Interest Rate

232
 ISLM Model

Agenda

https://www.youtube.com/shorts/pNKS6dIwimo?feature
=share

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233
 ISLM Model

Equilibrium Income and the Interest Rate

IS Curve : 𝑌 = 𝛼𝐺 𝐴ҧ − 𝑏𝑖

1 ഥ
𝑀
LM Curve : i = kY −
ℎ 𝑃

𝑏 ഥ
𝑀
𝑌 = 𝛼𝐺 ҧ
𝐴 − kY −
ℎ 𝑃

ഥ
𝑏 𝑀
𝑌 = 𝛾𝐴ҧ + 𝛾
ℎ 𝑃

234
 ISLM Model

Agenda

• equilibrium level of income depends on two exogenous

variables:

- autonomous spending
- the real money stock

235
 ISLM Model

Equilibrium Interest Rate

𝑘 1 𝑀ഥ
i= 𝛾 𝐴ҧ − 𝛾
ℎ ℎ𝛼𝐺 𝑃

236
 ISLM Model

Multipliers

• Fiscal Policy Multiplier

• Monetary Policy Multiplier

changes in fiscal policy or changes in the real money stock

237
 ISLM Model

The Fiscal Policy Multiplier

• The fiscal policy multiplier shows how much an increase

in government spending changes the equilibrium level of
income, holding the real money supply constant.

∆𝑌
= 𝛾
∆𝐺ҧ

ℎ𝛼𝐺
𝛾=
ℎ+𝑘𝑏𝛼𝐺

238
 ISLM Model

The Monetary Policy Multiplier

• The monetary policy multiplier shows how much an

increase in the real money supply increases the equilibrium
level of income, keeping fiscal policy unchanged.
∆𝑌 𝑏
ഥ 𝑃)
ത
= 𝛾
∆(𝑀/ ℎ

𝑏𝛼𝐺
𝛾=
ℎ+𝑘𝑏𝛼𝐺

239
Thank You

Rayees Ahmad Sheikh

[email protected]