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Ch 10 ECON 212

Ch 10 ECON 212 - Chapter10 Aggregate Demand I Building the...

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1 CHAPTER 10 Aggregate Demand I Chapter 10 Aggregate Demand I: Building the IS-LM Model
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2 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.
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3 CHAPTER 10 Aggregate Demand I Discussion of the current state of the  § 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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4 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 = planned investment PE =  +  I planned  +  G = planned expenditure Y = real GDP = actual expenditure § Difference between actual & planned expenditure = unplanned inventory investment
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5 CHAPTER 10 Aggregate Demand I Elements of the Keynesian Cross ( ) C C Y T = - I I = , G G T T = = = - + + ( ) PE C Y T I G = Y PE consumption function: for now, planned investment is exogenous: planned expenditure: equilibrium condition: govt policy variables: actual expenditure = planned expenditure
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6 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= Cplanned § Actual government expenditure=Planned government expenditure § G= Gplanned
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7 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: Ø interest rate Ø existing production capacity § and positively on: Ø expected future real GDP .
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8 CHAPTER 10 Aggregate Demand I Inventories and Unplanned  § 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.
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9 CHAPTER 10 Aggregate Demand I Investment  § Actual investment spending is the sum of planned investment spending and unplanned inventory investment. § I= Iplanned + Iunplanned
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CHAPTER 10 Aggregate Demand I Keynesian Cross Model (Income- 1. Changes in overall spending lead to changes in aggregate output. The aggregate price level is fixed. 2.
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Ch 10 ECON 212 - Chapter10 Aggregate Demand I Building the...

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