Class14 - Keynesian Cross The IS-Curve The LM-Curve IS-LM Model Class 14 Business Cycle the ISLM model ABC chapter 9(mostly and\/or Williamson chapter 13

Class14 - Keynesian Cross The IS-Curve The LM-Curve IS-LM...

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Keynesian Cross The IS-Curve The LM-Curve IS-LM Model Class 14, Business Cycle: the ISLM model ABC chapter 9 (mostly) and/or Williamson chapter 13 Julieta Caunedo CORNELL UNIVERSITY
Keynesian Cross The IS-Curve The LM-Curve IS-LM Model The IS-LM Model The Keynesian Cross The IS Curve : Equilibrium in the Goods Market The LM Curve : Asset Market Equilibrium Equilibrium in the Complete IS-LM Model IS-LM is the basis of the aggregate demand curve. We assume the price level is fixed . We also assume a closed economy .
Keynesian Cross The IS-Curve The LM-Curve IS-LM Model Short-Run vs. Long-Run Analysis Long run: Prices P flexible Output determined by factors of production & technology Unemployment equals its natural rate Short run: Prices P fixed Output determined by aggregate demand Unemployment negatively related to output IS-LM model determines income Y and the interest rate r when P is fixed IS-LM therefore focuses on short-run analysis.
Keynesian Cross The IS-Curve The LM-Curve IS-LM Model Keynesian Cross A simple closed economy model in which income is determined by expenditure. (due to J.M. Keynes) Notation: I = planned investment E = C + I + G = planned expenditure Y = real GDP = actual expenditure Difference between actual and planned expenditure = unplanned inventory investment
Keynesian Cross The IS-Curve The LM-Curve IS-LM Model Elements of The Keynesian Cross Consumption Function: C = C a + MPC × ( Y - T ) , 0 < MPC < 1 Investment: exogenous for now I = ¯ I Government: exogenous G = ¯ G , T = ¯ T So planned expenditure E = C a + MPC × ( Y - ¯ T ) + ¯ I + ¯ G Goods Market Equilibrium Condition: actual expenditure = planned expenditure Y = E Note: this is the same as saying that savings must equal planned investment: ( Y - ¯ T - C ) + ( ¯ T - ¯ G ) = ¯ I
An Increase in Government Spending
Keynesian Cross The IS-Curve The LM-Curve IS-LM Model Solving for Δ Y Y = C + I + G (equilibrium condition) Δ Y C + Δ I + Δ G (in changes) C + Δ G (I is exogenous) = MPC × Δ Y + Δ G (using consumption function) After solving for Δ Y : Δ Y = Δ G 1 - MPC
Keynesian Cross The IS-Curve The LM-Curve IS-LM Model Solving for Δ Y Δ Y = Δ G 1 - MPC Suppose MPC = 0 . 8 then a 1$ increase in G leads to a 1 1 - 0 . 8 = 5$ increase in income! Δ Y Δ G = 1 1 - MPC is the government spending multiplier .
An Decrease in Taxes Spending

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