CH 11 ECON 212

CH 11 ECON 212 - Aggregate Demand II Outline of this...

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1 CHAPTER 11 Aggregate Demand II Aggregate Demand II: § Outline of this chapter § Combine goods and money markets to look at the impact of various shocks on the equilibrium values of real interest rate (r) and real income (Y) § Derive AD curve from IS-LM Model § Great Depression(s)

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2 CHAPTER 11 Aggregate Demand II Can you find the slope of the IS curve  § Assume that the consumption function is given by C = 200 + 0.5(Y – T) and the investment function is I = 1,000 – 200r, where r is measured in percent, G equals 300, and T equals 200. § Yes. Substitute for C, I, and G in the equation Y = C + I + G and then write an equation for r as a function of Y. Slope of the IS curve will be the coefficient of Y .( –0.0025 )
3 CHAPTER 11 Aggregate Demand II IS curve Y   r r=7-0.0025Y 3 1600 § In equilibrium, S=I=400 § If r=4, Y=1600 S=400 I=200 § If r=2, Y=1600 S=400, I=600

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4 CHAPTER 11 Aggregate Demand II IS curve Y   r I=S S>I S<I
5 CHAPTER 11 Aggregate Demand II Find the slope of the LM curve for the  § Assume that the equilibrium in the money market may be described as M/P = 0.5Y – 100r, and M/P equals 800. § The slope of the LM curve is 0.005.

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6 CHAPTER 11 Aggregate Demand II LM curve Y   r r = –8 + 0.005Y. r 1 Y 1
7 CHAPTER 11 Aggregate Demand II LM curve Y   r Ms/P=L(r,Y) Ms/P<L(r,Y) Ms/P>L(r,Y)

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8 CHAPTER 11 Aggregate Demand II The intersection determines the unique combination of Y and r that satisfies equilibrium in both markets. The LM curve represents money market equilibrium. Equilibrium in the  IS   - LM     model The IS curve represents equilibrium in the goods market. ( ) ( ) Y C Y T I r G = - + + ( , ) M P L r Y = IS Y   r LM r 1 Y 1
9 CHAPTER 11 Aggregate Demand II Policy analysis with the  IS   - LM    model We can use the IS-LM model to analyze the effects of fiscal policy: G and/or T monetary policy: M ( ) ( ) Y C Y T I r G = - + + ( , ) M P L r Y = IS Y   r LM r 1 Y 1

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10 CHAPTER 11 Aggregate Demand II causing output & income to rise. IS 1 An increase in government purchases 1. IS curve shifts right Y   r LM r 1 Y 1 1 by 1 MPC G - IS 2 Y 2 r 2 1. 2. This raises money demand, causing the interest rate to rise… 2. 3. …which reduces investment, so the final increase in Y 1 is smaller than 1 MPC G - 3.
11 CHAPTER 11 Aggregate Demand II IS 1 1. A tax cut Y   r LM r 1 Y 1 IS 2 Y 2 r 2 Consumers save MPC ) of the tax cut, so the initial boost in spending is smaller for T than for an equal G and the IS curve shifts by MPC 1 MPC T - - 1. 2. 2. …so the effects on r and Y are smaller for T than for an equal G . 2.

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12 CHAPTER 11 Aggregate Demand II 2. …causing the interest rate to fall IS Monetary policy:  An increase in  M 1. M > 0 shifts the LM curve down (or to the right) Y   r LM 1 r 1 Y 1 Y 2 r 2 LM 2 3. …which increases investment, causing output & income to rise.
13 CHAPTER 11 Aggregate Demand II Interaction between  § Model: Monetary & fiscal policy variables

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This note was uploaded on 03/29/2011 for the course ECON 101 taught by Professor Medison during the Spring '11 term at MedU Ohio.

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CH 11 ECON 212 - Aggregate Demand II Outline of this...

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