Therefore the lm curve shifts downward lowering the

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Unformatted text preview: ry. He proposed that low aggregate demand was responsible for the low income and high unemployment of economic downturns. He criticized classical theory for assuming that aggregate supply alone determines national income. In this chapter we see that the government can influence aggregate demand with both monetary policy and fiscal policy. The IS- LM model is the leading interpretation of Keynes’s theory. The goal of the model is to show what determines national income for any given price level. The IS curve stands for “investment” and “saving,” represents what’s going on in the market for goods and services. The LM curve stands for “liquidity” and “money,” and the represents what’s happening to the supply and demand for money. Because the interest rate influences both investment and money demand, it is the variable that links the two halves of the IS- LM model. The model shows how interactions between these markets determine the position and slope of the AD curve, and therefore national income in the short run. The IS curve plots the relationship between the interest rate and the level of income that arises in the market for goods and services. Keynesian cross: the basic model if income determination which shows how changes in spending can have a multiplied affect on aggregate income. The Keynesian Cross The problem during recessions and depressions, according to Keynes, was inadequate spending. The Keynesian cross is an attempt to model this insight. Actual expenditure is the amount households, firms, and the government spend on goods and services, and equals GDP. Planned expenditure is the amount households, firms, and the government would like to spend on goods and services. The two may sometimes differ, for example if there is Page 30 of 52 Jessica Gahtan Prof: Mokhles Hossain Macroeconomics ECON2000 Fall 2013 unplanned inventory investment by firms who do not sell what they produce. Planned expenditure (E) = C + I + G. We assume that I = I¯,, G = G¯,, and T = T¯,, so we get: E = C(Y - T¯,) + I¯, + G¯, This equation shows that planned expenditure is a function income Y, the level of planned investment I¯,, and the fiscal policy variables G¯, and T¯,. Planned expenditure is an upward...
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