Chapter11 - Chapter Eleven 1 CHAPTER 11 Aggregate Demand...

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Unformatted text preview: Chapter Eleven 1 CHAPTER 11 Aggregate Demand II: Applying the IS-LM Model ® A PowerPoint Tutorial To Accompany MACROECONOMICS, 7th. Edition N. Gregory Mankiw Tutorial written by: Mannig J. Simidian B.A. in Economics with Distinction, Duke University M.P.A., Harvard University Kennedy School of Government M.B.A., Massachusetts Institute of Technology (MIT) Sloan School of Management Chapter Eleven 2 Now that we’ve assembled the IS-LM model of aggregate demand, let’s apply it to three issues: 1) Causes of fluctuations in national income 2) How IS-LM fits into the model of aggregate supply and aggregate demand in Chapter 9 3) The Great Depression Now that we’ve assembled the IS-LM model of aggregate demand, let’s apply it to three issues: 1) Causes of fluctuations in national income 2) How IS-LM fits into the model of aggregate supply and aggregate demand in Chapter 9 3) The Great Depression r Y LM(P ) IS r Y Chapter Eleven 3 I S- L M The intersection of the IS curve and the LM curve determines the level of national income, and the interest rate for a given price level. If the IS or LM curve shifts, the short-run equilibrium of the economy changes, and national income fluctuates. Let’s examine how changes in policy and shocks to the economy can cause these curves to shift. Chapter Eleven 4 IS LM r y Chapter Eleven 5 LM r Y IS A + ∆ G Consider an increase in government purchases. This will raise the level of income by ∆ G/(1- MPC ). IS ´ B The IS curve shifts to the right by ∆ G/( 1- MPC) which raises income and the interest rate. Chapter Eleven 6 LM r Y IS A- ∆ T Consider a decrease in taxes of ∆ T. This will raise the level of income by ∆ T × MPC/( 1- MPC). IS´ B The IS curve shifts to the right by ∆ T × MPC/( 1- MPC) which raises income and the interest rate. Chapter Eleven 7 IS LM r y Chapter Eleven 8 IS r Y LM A LM ′ B + ∆ M Consider an increase in the money supply. The LM curve shifts downward and lowers the interest rate which raises income. Why? Because when the Fed increases the supply of money, people have more money than they want to hold at the prevailing interest rate. As a result, they start depositing this extra money in banks or use it to buy bonds. The interest rate r then falls until people are willing to hold all the extra money that the Fed has created; this brings the money market to a new equilibrium. The lower interest rate, in turn, has ramifications for the goods market. A lower interest rate stimulates planned investment, which increases planned expenditure, production, and income Y. Chapter Eleven 9 The IS-LM model shows that monetary policy influences income by changing the interest rate. This conclusion sheds light on our analysis of monetary policy in Chapter 9. In that chapter we showed that in the short run, when prices are sticky, an expansion in the money supply raises income. But we didn’t discuss how a monetary expansion induces greater spending on goods and services—a process...
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This note was uploaded on 12/04/2011 for the course ECON 305 taught by Professor Neri during the Spring '11 term at American.

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Chapter11 - Chapter Eleven 1 CHAPTER 11 Aggregate Demand...

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