Ch10_Econ2020.pdf - Macroeconomics chapter 10 Aggregate Demand I Building IS-LM Model Instructor Mohamed Ebeid Fall 2018 IS \u2013 LM Model CHAPTER 10

# Ch10_Econ2020.pdf - Macroeconomics chapter 10 Aggregate...

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1 0 CHAPTER 10 Aggregate Demand I Macroeconomics chapter 10 Aggregate Demand I Building IS-LM Model Instructor Mohamed Ebeid IS – LM Model IN THIS CHAPTER, YOU WILL LEARN: the IS curve and its relation to: the Keynesian cross the loanable funds model the LM curve and its relation to: the theory of liquidity preference how the IS - LM model determines income and the interest rate in the short run when P is fixed 1 Fall 2018 Econ 2020_ Fall 201 8 201 8 - 10 - 30
2 2 CHAPTER 10 Aggregate Demand I Context Chapter 10 introduced the model of aggregate demand and aggregate supply. Long run: prices flexible output determined by factors of production & technology unemployment equals its natural rate Short run: prices fixed output determined by aggregate demand unemployment negatively related to output 3 CHAPTER 10 Aggregate Demand I The Keynesian cross A simple closed-economy model in which income is determined by expenditure. (due to J. M. Keynes) Notation: I = planned investment PE = C + I + G = planned expenditure Y = real GDP = actual expenditure Difference between actual & planned expenditure = unplanned inventory investment 201 8 - 10-30
3 4 CHAPTER 10 Aggregate Demand I Elements of the Keynesian cross ( ) C C Y T I I , G G T T ( ) PE C Y T I G Y PE consumption function: Planned investment is exogenous: planned expenditure: equilibrium condition: govt policy variables: actual expenditure = planned expenditure Y = C + G + I 5 CHAPTER 10 Aggregate Demand I The equilibrium value of income income, output, Y PE = Y PE = C + I + G Equilibrium income PE planned expenditure 45 º Equilibrium condition Y = PE Y = C+I+G MPC 1 201 8 - 10 - 30
4 6 CHAPTER 10 Aggregate Demand I An increase in government purchases Y PE PE = C + I + G 1 PE 1 = Y 1 PE = C + I + G 2 PE 2 = Y 2 Δ Y At Y 1 , there is now an unplanned drop in inventory… …so firms increase output, and income rises toward a new equilibrium. Δ G 7 CHAPTER 10 Aggregate Demand I The government purchases multiplier Example: If MPC = 0.8, then Definition: the increase in income resulting from a \$1 increase in G . In this model, the govt purchases multiplier equals 1 1 MPC Y G 1 5 1 0.8 Y G An increase in G causes income to increase 5 times as much!