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CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 1 Lecture 7
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CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 2 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
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CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 3 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
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CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 4 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
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CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 5      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.
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CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 6 2. …causing the  interest rate to fall  IS Monetary Policy: an increase in Monetary Policy: an increase in M 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.  
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CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 7 Interaction between Interaction between monetary & fiscal policy monetary & fiscal policy Model:   monetary & fiscal policy variables  ( M G   and  ) 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.  
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CHAPTER 11 CHAPTER 11 Aggregate Demand II Aggregate Demand II slide 8 The Fed’s response to The Fed’s response to G G > 0 > 0 Suppose Congress increases  G .
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