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321LecNote04Ch10_

# 321LecNote04Ch10_ - Instructor Kim H.H Fall 2009...

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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 1 Chapter 10. Aggregate Demand I : Building the IS-LM Model 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 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 ± 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

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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 2 presents the open-economy case. The Keynesian Cross ± A simple closed economy model in which income is determined by expenditure. (due to J.M. Keynes) ± Notation: I = _____________________ PE = C + I + G = _____________________ Y = ____________________________ ± Difference between actual & planned expenditure = __________________________ ______________________ Elements of the Keynesian Cross - consumption function: = C ______________________ - government policy variables GG = , TT = - for now, planned investment is exogenous: II = - planned expenditure : = PE __________________ - equilibrium condition: actual expenditure = planned expenditure _________________ Graphing planned expenditure income, output, Y PE planned expendi ture = C + I + G
Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 3 Graphing the equilibrium condition The equilibrium value of income An increase in government purchases income, output, Y PE planned expenditu re = 45º income, output, P E plann ed expe nditure = = C + I + G Equilibrium income

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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 4 Solving for Δ Y YCIG =++ Equilibrium condition Δ= Δ+ Δ in changes ___________ because I exogenous ___________ because ___________________ Collect terms with Y Δ on the left side of the equals sign : Solve for Y Δ Y The government purchases multiplier - Definition: the increase in income resulting from a \$1 increase in G . - In this model, the govt purchases multiplier equals * Example : If MPC = 0.8 then An increase in G causes income to increase ______ times as much.
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321LecNote04Ch10_ - Instructor Kim H.H Fall 2009...

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