Reading Notes-Chap 10 - Econ 232H Reading Notes Chapter 10 Aggregate Demand 1 Building the IS-LM Model IS-LM model leading interpretation of Keynes's

Reading Notes-Chap 10 - Econ 232H Reading Notes Chapter 10...

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Econ 232H Reading Notes Chapter 10 Aggregate Demand 1: Building the IS-LM Model IS-LM model, leading interpretation of Keynes’s theory. IS curve (investment and saving) LM curve (liquidity and money) Theory: economy’s total income was in the short run determined by spending plans of households, businesses and government. E=C(Y-T)+I+G Theory assumes that actual expenditure=planned expenditure (Y=E). Actual expenditure Y=E Planned expenditure E=C+I+G Government purchases multiplier ^ Y/^ G=1+MPC+MPC2+MPC3… Tax multiplier Change Y/Change T=-MPC/(1-MPC) Tax cuts stimulate aggregate supply by improving workers’ incentives and expand aggregate demand by raising households disposable income. A tax cut shifts planned expenditure upward, which increases equilibrium income. An increase in the interest rate lowers planned investment, which shifts planned expenditure downward, and lowers income. The IS summarizes these changes the goods market equilibrium.

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