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Unformatted text preview: 1 Chapter 9 A General Framework for Macroeconomic Analysis Introduction ¡ The 3 major markets in the economy: ¢ Labor Market (Chapter 3) ¢ Goods Market (Chapter 4) ¢ Asset Market (Chapter 7) ¡ In the previous chapters, we ¢ Define the equilibrium for each market ¢ Analyze the factors that affect the equilibrium of a particular market ¢ Ignore the linkages between different markets. Introduction ¡ This kind of analysis is called partial equilibrium analysis . ¡ In this chapter, we put these 3 markets together into a single framework that allows us to analyze them simultaneously. ¡ A situation in which all 3 markets are in equilibrium at the same time is called general equilibrium . Introduction ¡ We want to highlight 3 main variables: ¢ Real output / Real income ( Y ) ¢ Real interest rate ( r ) ¢ General price level ( P ) ¡ The framework that we use is called the IS-LM-FE framework. The IS Curve (Goods Market) ¡ Recall from Chapter 4 that the goods market is in equilibrium when the national saving and aggregate investment are equal. ¡ Graphically, the equilibrium is represented by the intersection point between the upward-sloping saving curve and the downward-sloping investment curve . Goods Market Equilibrium Real Interest Rate, r Aggregate Investment, I Investment Curve S (Y = 4,000) E 7% 2 Goods Market Equilibrium Real Interest Rate, r Aggregate Investment, I Investment Curve S (Y = 4,000) 7% S (Y = 5,000) Excess Supply of Savings F Goods Market Equilibrium Real Interest Rate, r Aggregate Investment, I Investment Curve S (Y = 4,000) E 7% 6% S (Y = 5,000) Explanations: ¡ Suppose the level of real output (Y) is 4,000. The associated saving curve is marked as S (Y = 4,000). ¡ The goods market equilibrium is represented by point E. ¡ In the graph, the real interest rate that clears the goods market is 7%. Explanations: ¡ Suppose now real income increases from 4,000 to 5,000 while all other factors are kept constant. ¡ According to the consumption-smoothing motive, when there is an increase in real income individual consumers will increase their current consumption and savings. ¡ This shifts the saving curve to the right. ¡ When r = 7%, there is an excess supply of savings. Hence the real interest rate will adjust downward. ¡ The new equilibrium is represented by point F. The IS Curve (Goods Market) ¡ This example shows that when real income (Y) increases , the real interest rate (r) has to adjust downward in order to clear the goods market....
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This note was uploaded on 08/11/2008 for the course ECON 103a taught by Professor Suen during the Winter '08 term at UC Riverside.
- Winter '08