004 Ch10 class notes

004 Ch10 class notes - 2/19/2011 Chapter 10 Aggregate...

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2/19/2011 1 Chapter 10 Aggregate Demand I: Building the IS-LM Model 1 CHAPTER 10 Aggregate Demand I What determines what? In the classical theory, Y determines C and S. For a given investment demand, change in S determines r. But, the effect of r on Y is muted in the classical theory. 2 CHAPTER 10 Aggregate Demand I Discussion of the current state of the economy First of all, the economy is bad. We need to stimulate the demand But, how? There are two views: (1) need government intervention to boost the demand. (2) pay down debt and reduce fiscal deficit and borrowing so that private sector will pick up the economic slowdown through improved expectations.
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2/19/2011 2 3 CHAPTER 10 Aggregate Demand I The Keynesian Cross A simple closed economy model in which income is determined by expenditure. (due to J.M. Keynes) Notation: I = planned investment PE = C + I + G = planned expenditure Y = real GDP = actual expenditure Difference between actual & planned expenditure = unplanned inventory investment 4 CHAPTER 10 Aggregate Demand I Elements of the Keynesian Cross () C C Y T  II ,  consumption function: for now, planned investment is exogenous: planned expenditure: equilibrium condition: govt policy variables: actual expenditure = planned expenditure 5 CHAPTER 10 Aggregate Demand I Planned Expenditure Under the assumption of fixed (rigid) prices: Planned Expenditure determines output in the short run. We also assume that Actual consumption=Planned aggregate consumption C= C planned Actual government expenditure=Planned government expenditure G= G planned
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2/19/2011 3 6 CHAPTER 10 Aggregate Demand I Investment Spending Planned investment spending is the investment spending that businesses plan to undertake during a given period. It depends negatively on: interest rate existing production capacity and positively on: expected future real GDP . 7 CHAPTER 10 Aggregate Demand I Inventories and Unplanned Investment Spending Inventories are stocks of goods held to satisfy future sales. Inventory investment is the value of the change in total inventories held in the economy during a given period. Unplanned inventory investment occurs when actual sales are more or less than businesses expected, leading to unplanned changes in inventories. 8 CHAPTER 10 Aggregate Demand I Investment Actual investment spending is the sum of planned investment spending and unplanned inventory investment. I= I planned + I unplanned
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2/19/2011 4 9 CHAPTER 10 Aggregate Demand I Keynesian Cross Model (Income- Expenditure Model) 1. Changes in overall spending lead to changes in aggregate output. The aggregate price level is fixed. 2. The interest rate is fixed.
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004 Ch10 class notes - 2/19/2011 Chapter 10 Aggregate...

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