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Ch_10 - AggregateDemandI BuildingtheIS LMmodel University...

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slide 1 Lecture Note-Chapter 10 Aggregate Demand I: Building the  IS   LM  model University of Waterloo Department of Economics Spring 2010
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slide 2  Introduction But this “long run” is a misleading guide to current affairs. “In the long run” we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past, the ocean is flat again. ……………John Maynard Keynes CHAPTER 10 Aggregate Demand I
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slide 3  Introduction This chapter and the next present a more detailed analysis of aggregate demand based on the IS–LM model. This model was developed by John Hicks in the 1930s as an interpretation of John Maynard Keynes’s seminal work, The General Theory of Employment, Interest and Money , and is based on an analysis of equilibrium in the goods and money markets, supposing that the price level is fixed. CHAPTER 10 Aggregate Demand I
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slide 4  Introduction We can interpret the IS–LM model in two distinct ways: First, as a theory of GDP determination, supposing that the price level is fixed, or, Second, as a theory of aggregate demand and so as part of an aggregate demand–aggregate supply model. CHAPTER 10 Aggregate Demand I
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slide 5 CHAPTER 10 Aggregate Demand I In this chapter, you will learn… the IS curve, and its relation to the Keynesian cross the loanable funds model the LM curve, and its relation to the theory of liquidity preference how the IS - LM model determines income and the interest rate in the short run when P is fixed.
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slide 6 CHAPTER 10 Aggregate Demand I Context Chapter 9 introduced the model of aggregate demand and aggregate supply. Long run prices flexible. output determined by factors of production & technology. unemployment equals its natural rate. Short run prices fixed. output determined by aggregate demand. unemployment negatively related to output.
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slide 7 CHAPTER 10 Aggregate Demand I Context This chapter develops the IS - LM model, the basis of the aggregate demand curve. We focus on the short run and assume the price level is fixed (so, SRAS curve is horizontal). This chapter (and chapter 11) focus on the closed-economy case. Chapter 12 presents the open-economy case.
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slide 8 Historical Context Of all the fluctuations in the world history, the one that stands out as particularly large, painful and intellectually significant is the Great Depression of the 1930s. This devastating episode caused many economists to question the validity of classical economic theory. Classical theory seemed incapable of explaining the Depression. CHAPTER 10 Aggregate Demand I
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slide 9 Historical Context Many economists believed that a new theory was needed to explain such a large and sudden economic downturn.
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