10CHAPTER 10Aggregate Demand IMacroeconomicschapter 10Aggregate Demand IBuilding IS-LM ModelInstructor Mohamed EbeidIS – LMModelIN THIS CHAPTER, YOU WILL LEARN:the IScurve and its relation to:the Keynesian crossthe loanable funds modelthe LMcurve and its relation to:the theory of liquidity preference how the IS-LMmodel determines income and the interest rate in the short run when Pis fixed1Fall 2018Econ 2020_Fall20182018-10-30
22CHAPTER 10Aggregate Demand IContextChapter 10 introduced the model of aggregate demand and aggregate supply. Long run:prices flexibleoutput determined by factors of production & technologyunemployment equals its natural rateShort run:prices fixedoutput determined by aggregate demandunemployment negatively related to output3CHAPTER 10Aggregate Demand IThe Keynesian crossA simple closed-economy model in which income is determined by expenditure. (due to J. M. Keynes)Notation: I= planned investmentPE= C + I + G= planned expenditureY= real GDP = actual expenditureDifference between actual & planned expenditure = unplanned inventory investment2018-10-30
34CHAPTER 10Aggregate Demand IElements of the Keynesian cross()CC YTII,GGTT()PEC YTIGYPEconsumption function:Planned investment is exogenous:planned expenditure:equilibrium condition:govt policy variables:actual expenditure = planned expenditureY = C + G + I5CHAPTER 10Aggregate Demand IThe equilibrium value of incomeincome, output,YPE=YPE=C +I +GEquilibrium incomePEplannedexpenditure45ºEquilibrium conditionY = PEY = C+I+GMPC12018-10-30
46CHAPTER 10Aggregate Demand IAn increase in government purchasesYPEPE=C +I +G1PE1= Y1PE=C +I +G2PE2= Y2ΔYAt Y1, there is now an unplanned drop in inventory……so firms increase output, and income rises toward a new equilibrium.ΔG7CHAPTER 10Aggregate Demand IThe government purchases multiplierExample: If MPC= 0.8, thenDefinition: the increase in income resulting from a $1 increase in G.In this model, the govt purchases multiplier equals11MPCYG1510.8YGAn increase in G causes income to increase 5 times as much!