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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 ISLM model, the basis of the aggregate demand curve. ¡ In Chapter 11, we will use the ISLM 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 ISLM 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.
 Spring '05
 Prodan
 Macroeconomics, ISLM Model

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