7) businesscycletheory1

7) businesscycletheory1 - Business Cycle Theory 1 Winter...

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0 Business Cycle Theory 1 Winter 2008 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 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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4 Context z This chapter 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 9) focus on the closed-economy case. Chapter 13 presents the open-economy case.
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5 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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6 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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7 Graphing planned expenditure income, output, Y E planned expenditure = C + I + G MPC 1
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8 Graphing the equilibrium condition income, output, Y E planned expenditure = 45 º
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9 The equilibrium value of income income, output, Y E planned expenditure = = C + I + G Equilibrium income
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10 An increase in government purchases E = Y = C + I + G 1 1 = 1 = + + 2 2 = 2 Δ At 1 , there is now an unplanned drop in inventory… …so firms increase output, and income rises toward a new equilibrium.
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This note was uploaded on 03/02/2010 for the course ECON ECON 102 taught by Professor Ohanian during the Winter '09 term at UCLA.

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7) businesscycletheory1 - Business Cycle Theory 1 Winter...

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