Chapter10 - CHAPTER10 AggregateDemand1 APowerPoint Tutorial...

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Chapter Ten 1 CHAPTER 10 Aggregate Demand 1:  Building the IS-LM Model ® A PowerPoint Tutorial To Accompany   MACROECONOMICS, 7th. Edition N. Gregory Mankiw Tutorial written by: Mannig J. Simidian B.A. in Economics with Distinction, Duke University  M.P.A., Harvard University Kennedy School of Government M.B.A., Massachusetts Institute of Technology (MIT) Sloan School of Management
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Chapter Ten 2 The Great Depression caused many economists to question the validity of classical economic theory (from Chapters 3-6). They believed they needed a new model to explain such a pervasive economic downturn and to suggest that government policies might ease some of the economic hardship that society was experiencing. In 1936, John Maynard Keynes wrote The General Theory of Employment, Interest, and Money. In it, he proposed a new way to analyze the economy, which he presented as an alternative to the classical theory. Keynes proposed that low aggregate demand is responsible for the low income and high unemployment that characterize economic downturns. He criticized the notion that aggregate supply alone determines national income.
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Chapter Ten 3 In 2008 and 2009, as the United States and Europe descended into a recession,  the Keynesian theory of the business cycle was often in the news. Policymakers  around the world debated how best to increase aggregate demand with both  monetary and fiscal policy.
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Chapter Ten 4 “Keynesian” means different things to different people. It’s useful to think of the basic textbook Keynesian model as an elaboration and extension of the “classical theory.” Its variable velocity of money and “sticky” prices reflects Keynes’s belief that the Classical model’s shortcomings arose from its overly-strict assumptions of constant velocity and highly flexible wages and prices. The model of aggregate demand (AD) can be split into two parts: IS model of the “goods market” and the LM model of the “money market.” “IS stands for Investment Saving, Whereas LM stands for Liquidity Money.”
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Chapter Ten 5 Price level, P Income, Output, Y SRAS AD Y* Y*' AD' AD'' Y*'' In the short run, when the price level is fixed, shifts in the aggregate demand curve lead to changes in national income, Y. The model of aggregate demand developed in this chapter called the IS-LM is the leading interpretation of Keynes’ work. The IS-LM model takes the price level as given and shows what causes income to change. It shows what causes AD to shift. The Keynesian model can be viewed as showing what causes the aggregate demand curve to shift.
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Chapter Ten 6 IS (investment and saving) model of the ‘goods market’ LM (liquidity and money) model of the ‘money market
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Chapter Ten 7 The IS curve (which stands for investment
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