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ch%2011 - MACROECONOMICS MACROECONOMICS CHAPT ER 11 Ag g re...

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MACROECONOMICS MACROECONOMICS C H A P T C H A P T E R E R Aggregate Demand II: Aggregate Demand II: Applying the Applying the IS-LM IS-LM Model Model 11 11

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2 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
3 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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4 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.
5 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 (1 - 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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6 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.
7 CHAPTER 11 Aggregate Demand II Interaction between  Model: Monetary & fiscal policy variables ( M , G, and T ) are exogenous. Real world:

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ch%2011 - MACROECONOMICS MACROECONOMICS CHAPT ER 11 Ag g re...

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