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Unformatted text preview: MACROECONOMICS MACROECONOMICS C H A P T C H A P T E R E R Aggregate Demand I: Aggregate Demand I: Building the Building the ISLM ISLM Model Model 10 10 2 CHAPTER 10 Aggregate Demand I Context 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 closedeconomy case. Chapter 12 presents the openeconomy case. 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 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 5 CHAPTER 10 Aggregate Demand I Graphing planned expenditure income, output, Y PE planned expenditure PE = C + I + G MPC 1 6 CHAPTER 10 Aggregate Demand I Graphing the equilibrium condition income, output, Y PE planned expenditure PE = Y 45 º 7 CHAPTER 10 Aggregate Demand I The equilibrium value of income income, output, Y PE planned expenditure PE = Y PE = C + I + G Equilibrium income 8 CHAPTER 10 Aggregate Demand I An increase in government purchases Y PE P E = Y PE = C + I + G 1 PE 1 = Y 1 PE = C + I + G 2 PE 2 = Y 2 ∆ Y At Y 1 , there is now an unplanned drop in inventory… …so firms increase output, and income rises toward a new equilibrium. ∆ G 9 CHAPTER 10 Aggregate Demand I Solving for ∆ Y Y C I G = + + Y C I G ∆ = ∆ + ∆ + ∆ MPC = × ∆ + ∆ Y G C G = ∆ + ∆ (1 MPC) ×∆ = ∆ Y G 1 1 MPC ∆ = × ∆ ÷ Y G equilibrium condition in changes because I exogenous because ∆ C = MPC ∆ Y Collect terms with ∆ Y on the left side of the equals sign: Solve for ∆ Y : 10 CHAPTER 10 Aggregate Demand I The government purchases multiplier Example: If MPC = 0.8, then Definition:...
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 Fall '11
 XiaoHuang
 ISLM Model

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