Chapter Eleven1®CHAPTER 11Aggregate Demand I IA PowerPointTutorialTo AccompanyMACROECONOMICS,6th. ed.N. Gregory MankiwByMannig J. Simidian
Chapter Eleven2Now that we’ve assembled the IS-LM model of aggregate demand, let’s apply it to three issues:1) Causes of fluctuations in national income2) How IS-LMfits into the model of aggregate supply and aggregate demand in Chapter 93) The Great DepressionrYLM(P0)ISr0Y0
Chapter Eleven3IS-LMThe intersection of the IScurve and the LM curve determines the level of national income, and the interest rate for a given price level. If the ISor LMcurve shifts, the short-run equilibrium of the economy changes, and national income fluctuates. Let’s examine how changes in policy and shocks to the economy can cause thesecurves to shift.
Chapter Eleven5LMrYISA+∆GConsider an increase in government purchases.This will raise the level of income by ∆G/(1- MPC)IS´BThe IScurve shifts to the right by ∆G/(1- MPC)which raises income and the interest rate.
Chapter Eleven6LMrYISA-∆TConsider a decrease in taxes of ∆T.This will raise the level of income by ∆T× MPC/(1- MPC)IS´BThe IS curve shifts to the right by ∆T× MPC/(1- MPC)which raises income and the interest rate.
Chapter Eleven8ISrYLMALM′B+∆MConsider an increase in the money supply.The LM curve shifts downward and lowers the interest rate which raises income. Why? Because when the Fed increases the supply of money, people have more money than they want to hold at the prevailing interest rate. As a result, they start depositing this extra money in banks or use it to buy bonds.The interest rate rthen falls until people are willing to hold all the extramoney that the Fed has created; this brings the money market to a new equilibrium. The lower interest rate, in turn, has ramifications for the goodsmarket. A lower interest rate stimulates planned investment, which increasesplanned expenditure, production, and income Y.
Chapter Eleven9The IS-LM model shows that monetary policy influences income bychanging the interest rate. This conclusion sheds light on our analysisof monetary policy in Chapter 9. In that chapter we showed that in the short run, when prices are sticky, an expansion in the money supply raises income. But we didn’t discuss how a monetary expansion induces greater spending on goods and services—a processcalled the monetary transmission mechanism.