Week 2 - The Economy in the Short Run: The IS-LM model

This week we are starting our study of the short-run fluctuations of the economy. Last week we saw that in the long run, the level of income of an economy depends mostly on the factors of production (K and L in our model). Because the factors of production of the economy are difficult to change, the output level will remain fixed around the long-run or natural level of output.

In the economy of the previous chapter, the variable that allows the economy to adjust back to its natural level of output in the long-run is the price level. When there is a change in the demand of goods and services, and the supply remains constant (due to factors of production being fixed in the short run), prices will go up because there will be excess demand. Higher prices will then bring output back to its original level.

In the short run, however, prices do not change. Prices take some time to adjust when there is a demand shock. Firms do not immediately adjust their prices from one month to another when they observe that demand is higher, they take some time to do so. This means that prices are fixed (rigid) in the short run. During the period of time that prices are fixed, changes in the demand do have some effects in the output level of the economy. This is what we study this week.

We start our study of the short run with the the help of the IS-LM model. This model is designed to study the short-run fluctuations of the economy around the long-run level of output.

 

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To Do:

• Review each section one at a time and in order. You should do the readings, then watch the videos and then complete the practice problems.
  • Section 11.1
  • Section 11.2
  • Section 11.3
• Next, ask questions on the Week 2 discussion board.
• Complete the quiz.
• Complete and Submit the assigned problems Download assigned problems
  from problem set 1.