lecture7 - CHAPTER 11 CHAPTER 11 Aggregate Demand II...

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Unformatted text preview: CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 0 Lecture 7 CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 1 Context Context ¡ Chapter 9 introduced the model of aggregate demand and supply. ¡ Chapter 10 developed the IS-LM model, the basis of the aggregate demand curve. ¡ In Chapter 11, we will use the IS-LM model to – see how policies and shocks affect income and the interest rate in the short run when prices are fixed – derive the aggregate demand curve – explore various explanations for the Great Depression CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 2 The intersection determines the unique combination of Y and r that satisfies equilibrium in both markets. The LM curve represents money market equilibrium. Equilibrium in the Equilibrium in the IS IS- LM LM Model Model The IS curve represents equilibrium in the goods market. ( ) ( ) Y C Y T I r G = − + + ( , ) M P L r Y = IS Y r LM r 1 Y 1 CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 3 Policy analysis with the Policy analysis with the IS IS- LM LM Model Model Policymakers can affect macroeconomic variables with • fiscal policy: G and/or T • monetary policy: M We can use the IS-LM model to analyze the effects of these policies. ( ) ( ) Y C Y T I r G = − + + ( , ) M P L r Y = IS Y r LM r 1 Y 1 CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 4 causing output & income to rise. IS 1 An increase in government purchases An increase in government purchases 1. IS curve shifts right Y r LM r 1 Y 1 IS 2 Y 2 r 2 1. 2. This raises money demand, causing the interest rate to rise… 2. 3. …which reduces investment, so the final increase in Y 3. CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 5 2. …causing the interest rate to fall IS Monetary Policy: an increase in Monetary Policy: an increase in M 1. ∆ M > 0 shifts the LM curve down (or to the right) Y r LM 1 r 1 Y 1 Y 2 r 2 LM 2 3. …which increases investment, causing output & income to rise. CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 6 Interaction between Interaction between monetary & fiscal policy monetary & fiscal policy ¡ Model: monetary & fiscal policy variables ( M , G and T ) are exogenous ¡ Real world: Monetary policymakers may adjust M in response to changes in fiscal policy, or vice versa. ¡ Such interaction may alter the impact of the original policy change. CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 7 The Fed The Fed ’s response to s response to ∆ G > 0 > 0 ¡ Suppose Congress increases G . ¡ Possible Fed responses: 1. hold M constant 2. hold r constant 3. hold Y constant ¡ In each case, the effects of the ∆ G are different: CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 8 If Congress raises G , the IS curve shifts right IS 1 Response 1: hold Response 1: hold M constant constant Y r LM 1 r 1 Y 1 IS 2 Y 2 r 2 If Fed holds...
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This note was uploaded on 04/14/2010 for the course ECON 3353 taught by Professor Prodan during the Spring '05 term at University of Alabama - Huntsville.

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lecture7 - CHAPTER 11 CHAPTER 11 Aggregate Demand II...

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