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Setting up the AD curve o Let’s start with our Keynesian Cross graph; this graph is what will eventually give us the shape of our AD curve. Make this graph BIG, as there will be a lot on it! Line #1: 45-degree line from the origin. This gives us the set of all possible equilibria (in this case, where expenditure and income are equal) Line #2: Consumption function; of form . This tells us exactly where we are at this very moment. o We’re now going to consider two consumption functions. Each has the same value of A, but one has an MPC of 0, and one has an MPC of 0.5. Assume our initial price level is p H . o If MPC is 0… Consumption will be a horizontal line (since you spend none of your income) So at a price level of p H , we have in equilibrium that If we lower the price level (see homework!), then people will buy more at all income levels. For now we view this as a shift straight upwards in the consumption function, that is, A (the y-intercept) rises. So at a price level of p

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