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Hen@222
Sagandykova
MACROECONOMICS
LECTURE 11
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Aggregate Demand I:
Building the IS–LM Model
Prepared by:
1
Outline
1. 11-1 The Goods Market and the IS Curve
2. 11-2 The Money Market and the LM Curve
3. 11-3 Conclusion: The Short-Run Equilibrium
2
Aggregate Demand I: Building the IS–LM Model
1. Our goal is
a. to identify the variables that shift the AD curve, causing fls in national Y.
b. to examine the tools policymakers can use to ﬧA D .
2. (Ch. 10) We showed that monetary policy can shift the AD curve.
3. (this Ch.) We see that the government can ﬧAD with both
• monetary and fiscal policy.
IS–LM model,
a. is the leading interpretation of Keynes’s theory.
b. The goal of the model is to show what determines national Y for a
given P.
We can view the IS–LM model as showing what causes
c. Y to change in the SR when the P is fixed because all Ps are sticky
d. the AD curve to shift.
Aggregate Demand I: Building the IS–LM Model
6
11-1 The Goods Market and the IS Curve
The IS curve plots the relationship between the r & the level of Y
• that arises in the market for G&Ss.
To develop this relationship, we start with the Keynesian cross –
The Interest Rate, Investment, and the IS Curve
Planned Expenditure
Let us draw a distinction between actual & planned expenditure.
Actual expenditure
The Interest Rate, Investment, and the IS Curve
3.
• As in Ch.3, we assume that fiscal policy— the levels of G & T—is
fixed:
4.
5.
The Keynesian Cross
• Y as GDP = not only total Y but also total AE on G&S, we can write
this equilibrium condition as
AE = PE
Y = PE.
The Keynesian Cross
The 45-degree line plots the points where this condition holds.
• With the addition of the PE function, this diagram becomes the
KC.
How does the
economy get to
equilibrium?
Whenever an
economy is not in
equilibrium, Fs
experience
• unplanned changes
in inventories, →
• Changes in
production levels →
• Changes in total Y
and expenditure →
• equilibrium.
• If Fs are
producing at level
Y1,
then PE1 falls short
of production, and
Fs accumulate
inventories.
• This inventory
accumulation
induces Fs to ↘
production.
• Similarly, if Fs are producing at level Y2, then PE2 exceeds production, and Fs run down
their inventories.
• This fall in inventories induces Fs to increase production.
• In both cases, the Fs ’ decisions drive the economy toward equilibrium.
11-1 The Goods Market and the IS Curve
• An ↗ of G
raises PE by
that amount for
any given level
of Y.
• The equilibrium
moves from
point A to point
B, and Y rises
from Y1 to Y2.
When President Barack Obama took office in January 2009, the economy was
suffering from a significant recession.
• The package included some tax cuts and higher transfer payments, but much
of it was made up of ↗ in G of G&S.
Congress went ahead with President Obama’s proposed stimulus plans with
relatively minor modifications.
• The president signed the $787 billion billon February 17, 2009.
Did it work?
• The economy did recover from the recession,
• but much more slowly than the Obama administration economists initially
forecast.
Whether the slow recovery reflects
1. the failure of stimulus policy or
2. a sicker economy than the economists first appreciated
is a question of continuing
Study
debate.
Case
11-1 The Goods Market and the IS Curve
The KС
• explains the economy’s AD curve
• shows how the spending plans of H, F, the G determine the Y.
The Interest Rate, Investment, and the IS Curve
Changes in FP that
The Keynesian Cross
The LM curve shows the combinations of the interest rate and the
level of Y that are consistent with equilibrium in the market for RMB.
The LM curve is drawn for a given supply of RMB.
• ↘ in the supply of RMB shift the LM curve u↑.
Income, Money Demand, and the LM Curve