mankiw7e-chap10

mankiw7e-chap10 - 10 Aggregate Demand I: Aggregate Building...

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Aggregate Demand I: Building the IS -LM LM Model Model 10 10 In this chapter, you will learn: the IS curve, and its relation to: the Keynesian cross the LM curve, and its relation to: the theory of liquidity preference how the IS - LM model determines income and the interest rate in the short run when P is fixed Context Chapter 9 introduced the model of aggregate demand and aggregate supply. Long run prices flexible output determined by factors of production & technology unemployment equals its natural rate Short run prices fixed output determined by aggregate demand unemployment negatively related to output
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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 closed-economy case. The Keynesian Cross (Simple Keynesian) Model A simple closed economy model in which income is determined by expenditure. Notation: I = planned investment PE = C + I + G = planned expenditure (note!) Older edition uses E = C + I + G Y = real GDP = actual expenditure Difference between actual & planned expenditure = unplanned inventory investment Elements of the Keynesian Cross Model ( ) 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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Planned Consumption Expenditure income, output, Y C planned consumption C = mpc x (Y-T) MPC 1 Graphing planned expenditure income, output, Y PE planned expenditure PE = C + I + G MPC 1 45 O line - Graphing the equilibrium condition income, output, Y PE planned expenditure PE = Y 45º
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The equilibrium value of income income, output, Y PE planned expenditure PE = Y PE = C + I + G Equilibrium income Why this is the equilibrium value of income. income, output, Y PE planned expenditure PE = Y PE = C + I + G Equilibrium income An increase in government purchases Y PE PE = 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.
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mankiw7e-chap10 - 10 Aggregate Demand I: Aggregate Building...

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