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### mankiw7e-chap10_Slides 1 to 14

Course: ECON 305, Spring 2011
School: Maryland
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Word Count: 501

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Demand 10 Aggregate I: Aggregate Building the IS-LM Model Building IS In this chapter, you will learn: the IS curve, and its relation to: the Keynesian cross the LM curve, and its relation to: the theory of liquidity preference how the IS-LM model determines income and the interest rate in the short run when P is fixed Context Chapter 9 introduced the model of aggregate demand and aggregate supply....

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Demand 10 Aggregate I: Aggregate Building the IS-LM Model Building IS In this chapter, you will learn: the IS curve, and its relation to: the Keynesian cross the LM curve, and its relation to: the theory of liquidity preference how the IS-LM model determines income and the interest rate in the short run when P is fixed Context Chapter 9 introduced the model of aggregate demand and aggregate supply. Long run prices flexible output determined by factors of production & technology unemployment equals its natural rate Short run prices fixed output determined by aggregate demand unemployment negatively related to output Context This chapter develops the IS-LM model, the basis of the aggregate demand curve. We focus on the short run and assume the price level is fixed (so, SRAS curve is horizontal). This chapter (and chapter 11) focus on the closed-economy case. The Keynesian Cross (Simple Keynesian) Model A simple closed economy model in which income is determined by expenditure. Notation: I = planned investment PE = C + I + G = planned expenditure (note!) Older edition uses E = C + I + G Y = real GDP = actual expenditure Difference between actual & planned expenditure = unplanned inventory investment Elements of the Keynesian Cross Model consumption function: C C ( T ) Y govt policy variables: G G , T T for now, planned investment is exogenous: planned expenditure: I I PE C ( T ) I G Y equilibrium condition: actual expenditure = planned expenditure Y PE Planned Consumption = Expenditure C planned consumption C mpc x (Y-T) MPC 1 income, output, Y Graphing planned expenditure PE planned expenditure PE =C +I +G MPC 1 income, output, Y 45O line - Graphing the equilibrium condition PE planned expenditure PE =Y 45 income, output, Y The equilibrium value of income PE planned expenditure PE =Y PE =C +I +G income, output, Y Equilibrium income Why this is the equilibrium value of income. PE planned expenditure PE =Y PE =C +I +G income, output, Y Equilibrium income An increase in government purchases PE = Y PE At Y1, there is now an unplanned drop in inventory PE =C +I +G2 PE =C +I +G1 G so firms increase output, and income rises toward a new equilibrium. Y PE1 = Y1 Y PE2 = Y2 Solving for Y Y C I G equilibrium condition Y C I G in changes C G MPC Y G Collect terms with Y on the left side of the equals sign: (1 MPC) Y G because I exogenous because C = MPC Y Solve for Y : 1 Y G 1 MPC The government purchases multiplier Definition: the increase in income resulting from a \$1 increase in G . In this model, the govt purchases multiplier equals Y 1 G 1 MPC Example: If MPC = 0.8, then Y 1 5 G 1 0.8 An increase in G An increase in G causes income to causes income to iincrease 5 times ncrease 5 times as much! as much! Why the multiplier is greater than 1 Initially, the increase in G causes an equal increase in Y : Y = G. But Y C further Y further C further Y So the final impact on income is much bigger than the initial G.
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Maryland - ECON - 305
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Fayetteville State University - COP - 5621
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Fayetteville State University - CDA - 3100
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Fayetteville State University - CDA - 3100
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Fayetteville State University - CDA - 3100
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Fayetteville State University - CDA - 3100
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Fayetteville State University - CDA - 3100
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Fayetteville State University - CDA - 3100
Fayetteville State University - CDA - 3100
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Fayetteville State University - CDA - 3100
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Fayetteville State University - CDA - 3100
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Fayetteville State University - CDA - 3100
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Fayetteville State University - CDA - 3100
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UC Riverside - ECON - 1000
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UC Riverside - ECON - 1000
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UC Riverside - ECON - 1000
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