Lecture Notes 9.pdf - Chapter 9 The IS-LM/AD-AS Model A...

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Chapter 9: The IS-LM/AD-AS Model: A General Framework for Macroeconomic Analysis Tingjun Liu FBE of HKU March 6, 2018 T Liu (FBE of HKU) MFIN7007 March 6, 2018 1 / 61
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Chapter Outline ° Discuss factors that affect the the full-employment ( FE ) Line (Equilibrium in the labor market). ° Discuss factors that affect the IS Curve (equilibrium in the goods market). ° Discuss factors that affect the LM Curve (asset market equilibrium). ° Describe the conditions necessary for general equilibrium using the complete IS ± LM model. ° Discuss the role of price adjustment in achieving general equilibrium. ° Explain the fundamentals and implications of the AD ± AS model. T Liu (FBE of HKU) MFIN7007 March 6, 2018 2 / 61
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The FE Line: Equilibrium in the Labor Market ° We have discussed three main markets of the economy: the labor market, the goods market, and the asset market. In this chapter we discuss how they fit into a complete macro system. ° Labor market in Chapter 3 showed how equilibrium in the labor market leads to employment at its full-employment level ( N ) and output at its full-employment level ( Y ). ° Our ultimate objective is a diagram that has the real interest rate on the vertical axis and output on the horizontal axis. ° If we plot output against the real interest rate, we get a vertical line, since labor market equilibrium is unaffected by changes in the real interest rate (Fig. 9.1). T Liu (FBE of HKU) MFIN7007 March 6, 2018 3 / 61
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T Liu (FBE of HKU) MFIN7007 March 6, 2018 4 / 61
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The FE Line ° Factors that shift the FE line. The full employment level of output is determined by the full-employment level of employment and the current levels of capital and productivity; any change in these variables shifts the FE line. ° Summary 11 lists the factors that shift the full-employment line. The full-employment line shifts right because of: ° a beneficial supply shock. ° an increase in labor supply. ° an increase in the capital stock. ° The full-employment line shifts left when the opposite happens to the three factors above. T Liu (FBE of HKU) MFIN7007 March 6, 2018 5 / 61
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T Liu (FBE of HKU) MFIN7007 March 6, 2018 6 / 61
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IS Curve: Equilibrium in the Goods Market ° The goods market clears when desired investment equals desired national saving, or equivalently when the aggregate quantity of goods supplied equals the aggregate quantity of goods demanded: ° The IS curve shows for any level of output Y , the real interest rate r for which the goods market is in equilibrium. ° Adjustments in the real interest rate help bring about equilibrium in the goods market. T Liu (FBE of HKU) MFIN7007 March 6, 2018 7 / 61
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Deriving IS Curve from Investment Curve and Savings Curve ° Derivation of the IS curve from the saving-investment diagram (Fig. 9.2). ° The investment curve ° slopes downward because a higher real IR reduces the desired capital stock, thus reducing investment.
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