businesscycletheory1

businesscycletheory1 - Business Cycle Theory 1 Winter 2009...

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0 Business Cycle Theory 1 Winter 2009 UCLA Professor Mark Wright
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1 Aggregate Demand I: Building the IS - LM Model Winter 2008 UCLA Professor Mark Wright
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2 In this section, you will learn… z the IS curve, and its relation to the Keynesian cross the loanable funds model z the LM curve, and its relation to the theory of liquidity preference z how the IS - LM model determines income and the interest rate in the short run when P is fixed
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3 You’ll also learn … z What people are talking about when people in Washington talk about a ``multiplier effect’’ of fiscal policy on output. z How big is the multiplier? Much controversy: For tax changes: z 3 C. and D. Romer (2007) (Christy Romer is chair of Obama’s council of economic advisors) For spending: z 1.6 C. Romer (2008) z 1 B. Hall and S. Woodward (2008) z 1.4 V. Ramey (2008) z Zero in peacetime R. Barro (2008) z 0.8 in wartime R. Barro (2008) z You’ll also learn why some people (e.g. Krugman) say saving is bad at a time like this (the “paradox of thrift”)
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4 Context z Last time we introduced the model of aggregate demand and aggregate supply. z Long run prices flexible output determined by factors of production & technology unemployment equals its natural rate z Short run prices fixed output determined by aggregate demand unemployment negatively related to output
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5 Context z Chapter 10 develops the IS - LM model, the basis of the aggregate demand curve. z We focus on the short run and assume the price level is fixed (so, SRAS curve is horizontal). z This chapter (and chapter 11) focus on the closed-economy case. Chapter 12 presents the open-economy case.
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6 The Keynesian Cross z A simple closed economy model in which income is determined by expenditure. (due to J.M. Keynes) z Notation: I = planned investment E = C + I + G = planned expenditure Y = real GDP = actual expenditure z Difference between actual & planned expenditure = unplanned inventory investment
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7 Elements of the Keynesian Cross () CC Y T = II = , GG TT = = EC I G = −+ + = E consumption function: for now, planned investment is exogenous: planned expenditure: equilibrium condition: govt policy variables: actual expenditure = planned expenditure
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8 Graphing planned expenditure income, output, Y E planned expenditure = C + I + G MPC 1
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9 Graphing the equilibrium condition income, output, Y E planned expenditure = 45 º
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10 The equilibrium value of income income, output, Y E planned expenditure = = C + I + G Equilibrium income
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businesscycletheory1 - Business Cycle Theory 1 Winter 2009...

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