Lecture16 - Readings Today Review: Mankiw, ch. 9. Intro to...

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1 Readings Today • Review: Mankiw, ch. 9. Intro to Economic Fluctuations. AS-AD model • Mankiw, ch 10. IS-LM model Thursday • Mankiw, ch. 11. Policy in IS-LM model Next Thursday • Mankiw, ch 5, ch 12. Open economy Midterm: Tuesday Nov 16 Special rooms (check CTools/Lecture Thurs) Topics: • Cumulative, through this week • Emphasis on topics since Midterm #1 – Unemployment – Money and prices – Solow model/Economic growth – AS/AD IS / LM not included on Midterm #2 Announcements • PS 6 due now • Answers to practice Midterm #2 posted today – Advice: Attempt practice before looking at answers • Section 008 (Shapiro) – Location moved to Lorch 201
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2 Roadmap/Overview Full-employment model • Investment = Saving • Output determined by supply: Y=F(K,L) • Interest rates adjustment to clear markets • Unemployment at full-employment: search • Steady inflation Roadmap/Overview Evolution of full-employment output • Exogenous sources of growth • Labor force • Technology • Endogenous response of capital • Leads to steady state with • Constant MPK • Balanced growth • Output growing at rate n+g • Consumption per head, wages growing at g Roadmap/Overview Deviations from full-employment • Recessions and booms • Fixed prices allow aggregate demand to affect output • Slow adjustment of prices gradually restores full employment
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3 Roadmap/Overview AS/AD model • Output/Price level determination • Supports deviations of output from Y * • Dynamics of restoration of full employment IS/LM model • Detailed model of AD – Reintroducing the interest rate – Fiscal and monetary policy in the short run • Remark: Solution of IS/LM traces out AD Trend determined by population growth, technology, and capital accumulation Deviations from trend: Business cycle 7.5% gap
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4 Deviations from Full-employment Y-Y * = -7.5% • 3-years trend growth • 7 million jobs Why does output/employment not increase to quickly restore Y=Y * ? • Prices/wages “sticky” deviation from full employment • Shifts in demand will affect output • Fiscal and monetary policy can affect output From quantity equation to aggregate demand Quantity equation: M·V = P·Y Assumption: Constant velocity V=1/k Quantity equation becomes money demand: (M/P) d = kY Aggregate Demand: Introducing ( Y,P )-space Money demand: (M/P) d = kY Hold money, k constant Aggregate demand: AD: P = M/(kY)
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5 The downward-sloping AD curve An increase in the
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Lecture16 - Readings Today Review: Mankiw, ch. 9. Intro to...

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