Determination Of CF, NX And ER With The Help Of IS- LM Model

Determination Of CF, NX And ER With The Help Of IS- LM Model:

IS equation: Y = C(Y – T) + I(r) + G + NX (є) …(1)

LM equation:

M/P = L(r, Y) …(2)

Capital inflows takes place Reason: foreign investors will find it profitable to invest here because they will get a high interest rate on the loan given.

Result:

CF will decrease

Similarly if r falls; r < r*

vice versa will take place.

Relation between NX and ER:

(i) Equilibrium interest rate is determined where:

IS = LM

IS = LM at point E

.^.. Equilibrium interest rate → r₁

Equilibrium income level → Y₁

(ii) At interest rate – r₁

CF is CF₁ (Fig. b 17.5)

When CF is CF₁

NX is NX₁(Fig. c 17.5)

ER is є₁

And thus equilibrium CF is CF₁

Where: NX is NX₁ and ER is є₁