Course: EC2B5 Topic: Complete Guide to EC2B5
This guide consolidates material from lecture transcripts, class notes, ED forum discussions, and exter
resources. As long as the syllabus remains unchanged, you won’t need to refer to the lecture slides —
everything required to achieve a first is included here.
Note:
Readings that were mentioned in the problem sets are essential.
SR = Short Run, LR = Long Run.
,Course: EC2B5 Topic: Complete Guide to EC2B5
Week 1 (ISLM, ADAS, and Phillips Curve):
The IS-LM model:
o ISLM stands for “Investment, Savings, Liquidity and Money”.
o This tool allows us to understand the short-run state of the economy. However, it can’t be utilized for the l
run.
o The ISLM model is useful when an economic shock takes place. This is it assists in understanding how
governments can use the levers of the fiscal and monetary policy to stabilize the economy.
o In addition, the ISLM curve allows us to interpret changes in Consumption, Income and Interest Rates duri
economic shock.
o The IS curve represents goods market equilibrium (the goods and services market):
Determines equilibrium income
Goods market equilibrium requires:
Aggregate Supply (AS) = Aggregate Demand (AD)
AS = Total production of goods by firms. It consists of:
o Consumption (increasing in Y)
o Investment (decreasing in r)
o Government spending (fixed)
AD = Total spending on goods by households
The IS curve represents all possible combinations of (Y, r) for which goods market is in equilibrium.
,Course: EC2B5 Topic: Complete Guide to EC2B5
Note: Y = Q (real GDP); the terms are interchangeable.
Remember that changes in interest rates are represented as movements along the M D curve. Howev
changes in income are represented as shifts in the M D curve.
Note: generically, if a variable is represented on the axis then changes in that variable will always be a
along the curve. However, if a related variable is not on the axis then changes in that variable is always
in the curve.
, Course: EC2B5 Topic: Complete Guide to EC2B5
o Let’s assume that the economy is going through a shock and the Government increases spending:
The IS curve subsequently shifts outwards – Government spending is an element of AD.
The Gov spending in this case was £30B, however the overall spending increased by £100B. This is kno
the Keynesian multiplier effect.
However, the increase was expected to be more than £100B, but due to crowding out effect the shift
was much smaller. Crowding out effect is the reduction in private sector activities due to Government
intervention.
The AD-AS model:
o Similar to ISLM, the AD-AS model also studies SR economic fluctuations. However, this tool is more sophist
and touches upon the shortcomings of the ISLM model.
o Key Shortcomings of ISLM:
Prices are fixed
The equilibrium level of output is determined purely by AD
This guide consolidates material from lecture transcripts, class notes, ED forum discussions, and exter
resources. As long as the syllabus remains unchanged, you won’t need to refer to the lecture slides —
everything required to achieve a first is included here.
Note:
Readings that were mentioned in the problem sets are essential.
SR = Short Run, LR = Long Run.
,Course: EC2B5 Topic: Complete Guide to EC2B5
Week 1 (ISLM, ADAS, and Phillips Curve):
The IS-LM model:
o ISLM stands for “Investment, Savings, Liquidity and Money”.
o This tool allows us to understand the short-run state of the economy. However, it can’t be utilized for the l
run.
o The ISLM model is useful when an economic shock takes place. This is it assists in understanding how
governments can use the levers of the fiscal and monetary policy to stabilize the economy.
o In addition, the ISLM curve allows us to interpret changes in Consumption, Income and Interest Rates duri
economic shock.
o The IS curve represents goods market equilibrium (the goods and services market):
Determines equilibrium income
Goods market equilibrium requires:
Aggregate Supply (AS) = Aggregate Demand (AD)
AS = Total production of goods by firms. It consists of:
o Consumption (increasing in Y)
o Investment (decreasing in r)
o Government spending (fixed)
AD = Total spending on goods by households
The IS curve represents all possible combinations of (Y, r) for which goods market is in equilibrium.
,Course: EC2B5 Topic: Complete Guide to EC2B5
Note: Y = Q (real GDP); the terms are interchangeable.
Remember that changes in interest rates are represented as movements along the M D curve. Howev
changes in income are represented as shifts in the M D curve.
Note: generically, if a variable is represented on the axis then changes in that variable will always be a
along the curve. However, if a related variable is not on the axis then changes in that variable is always
in the curve.
, Course: EC2B5 Topic: Complete Guide to EC2B5
o Let’s assume that the economy is going through a shock and the Government increases spending:
The IS curve subsequently shifts outwards – Government spending is an element of AD.
The Gov spending in this case was £30B, however the overall spending increased by £100B. This is kno
the Keynesian multiplier effect.
However, the increase was expected to be more than £100B, but due to crowding out effect the shift
was much smaller. Crowding out effect is the reduction in private sector activities due to Government
intervention.
The AD-AS model:
o Similar to ISLM, the AD-AS model also studies SR economic fluctuations. However, this tool is more sophist
and touches upon the shortcomings of the ISLM model.
o Key Shortcomings of ISLM:
Prices are fixed
The equilibrium level of output is determined purely by AD
