ECON 2000 - Chapter 11 Notes - Chapter 11 Aggregate Demand II Applying the IS-LM Model 11.1 Explaining Fluctuations With the IS-LM Model when either the

ECON 2000 - Chapter 11 Notes - Chapter 11 Aggregate Demand...

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Chapter 11: Aggregate Demand II – Applying the IS-LM Model 11.1 Explaining Fluctuations With the IS-LM Model when either the IS or LM curve shifts, short-run equilibrium of the economy changes, and national income fluctuates changes in fiscal policy – government expenditures and taxes o government expenditures: increase in government spending raises the level of income at any given interest rate by the government-purchases multiplier IS curve shifts rightward by ∆G 1 MPC recall from goods market : when government increases its purchases, economy's planned expenditures increase, in which stimulates production of g/s, and thus causes Y to rise recall from money market : when Y increases, demand for money increases at every interest rate; since supply of money has not changed, interest rate rises higher interest rates has ramifications back in goods market firms cut back on their investment, and fall in investment partially offsets expansionary effect of the increase in government purchases increase in income is smaller in the IS-LM model than it is in Keynesian cross (where I is assumed fixed), explained by the crowding out of investments o tax changes: a tax cut affects expenditures through consumption raises level of income at any given interest rate by the tax multiplier IS curve shifts rightward by ∆T ( MPC 1 MPC ) tax cut raises both Y and interest rate, and once again because of a higher interest rate, it crowds out investment (Y ultimate increases by less than the tax multiplier)
3. Holding Income Constant

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