Chapter 10 Aggregate Demand, I.
Chapter 11 Aggregate Demand, I.
IS-LM
H.W. p 325-26 #1, 4a, c
Macromodel: deriving_is_lm 1, 2, 4
(Might email handout on
derivations)
Need big picture: IS-LM for AD: IS is equilibrium in goods
market, LM is equilibrium in money market, with interest
rate being equilibrating variable. We do Keynesian cross
first.
Review terminology of exogenous and endogenous.
Working with IS-LM
For each curve, two exercises can be performed.
First, the derivation of the curve. Secondly, how a
change in a key variable, such as M or G, moves
the curve. Understanding the first is necessary for
understanding the second. It is hard to keep these
straight. Knowing how to derive the curve allows
one to speak of what determines the slopes of the
curves.
DERIVATION OF A CURVE: for given values
of the exogenous variables, show how changes in
one endogenous variable (which would cause
disequilibrium) can counteracted by a change in
another endogenous variable to regain
equilibrium
(2) Shifts of the IS curve. This is illustrated for an
increase in G (Figure 10-8), although it can also
be done for changes in exports, imports,
autonomous investment, taxes, etc. Keeping
constant one of r or Y (r in the example), how
would an increase in G leads to a change in Y in
order to maintain equilibrium in the goods
market.
LM Curve: Equilibrium in the money market,
Ms = Md
MOVEMENTS OF A CURVE For a given value
of one endogenous variable, show how a change
in an exogenous variable affects the value of the
other endogenous variable.
(3) Derivation of LM. Holding the quantity of
Money M constant, Figure 10-12 shows how
changing r necessitates a change in Y in order to
maintain equilibrium in the money market.
IS curve: equilibrium in the goods market:
Y = C+I+G
An extra result (corollary) is that the steeper is the
Md, the steeper is the LM. This result is seen to
support the Monetarists.
(1) For a given investment demand curve [Figure
10-7(a)] (and keeping constant G and T) shows
how a change in r would require a change in Y, in
order to maintain equilibrium.
Working with IS-LM
One can see that the steeper the I(r) curve, the
steeper the IS.
(2) Shift of the LM. Typically this is caused by a
change in M, although we will later see that it can
also be caused by a change in prices. Figure 10-
Mankiw P. 312. On Keynesian policy.
Mankiw,
Chapter 11,
p. 312
Fig. 10-1, P. 258. Shifts in AD.
Fig. 11-1, p. 304. Shifts in AD.
IS-LM will explain shifts in AD.
Starts off with Keynesian cross. E is
total expenditure, closed economy.
2
Fig. 10-2, p. 260. Planned Expenditure as
a Function of Income
Fig. 10-3, p. 261. The Keynesian Cross
Fig. 11-2, p. 306. Planned
Expenditure as a Function of Income
E = C(Y-Tbar) + Ibar + Gbar.
Fig. 11-3, p. 307. The Keynesian
Cross
Illustration of equilibrium.
Fig. 10-4, p. 262. Adjustment to Equilibrium
in the Keynesian Cross
Fig. 11-4, p. 308. Adjustment to
Equilibrium in the Keynesian Cross
Via changes in inventory
Fig. 10-5, p. 263. An Increase in Government
Purchases in the Keynesian Cross
Fig. 11-5, p. 309. An Increase in
Government Purchases in the
Keynesian Cross.
Increase income, with a multiplier.
ΔY = ΔG x (1 + MPC + MPC2…)
Or mult=1/(1-MPC).
Alternatively, Y=(cYcTbar+Ibar+Gbar), etc.
Fig. 11-6, p. 311. A Decrease in
Taxes in the Keynesian Cross.
ΔG/ΔT = MPC/(1-MPC)
Mentions Kennedy and tax cuts to
stimulate the economy.
Mentions supply side version of tax
cuts.
Fig. 10-6, p. 265. A Decrease in Taxes
in the Keynesian Cross.
3
IS curve: combinations of interest rates and income that give
equilibrium in the goods market.
Fig. 10-7, p. 267.
Deriving the IS
Curve
Fig. 11-7, p. 315. Deriving the IS
Curve
Fig. 10-8, p. 269.
An Increase in
Gov’t Purchases
Shifts the IS
Curve
Fig. 11-8, p. 316. An Increase in
Gov’t Purchases Shifts the IS Curve
LM curve: equilibrium in money market.
Explained by liquidity preference.
Earlier edition discussed how these two models are equivalent.
Fig. 10-10, p. 272. The Theory of Liquidity Preference
Fig. 11-9, p. 318. The Theory of
Liquidity Preference.
(M/P)d = L(r)
Hides issue of r or i.
Fig. 10-10, p. 303. A Reduction in the Money
Supply in the Theory of Liquidity Preference.
Fig. 11-10, p. 319. A Reduction in
the Money Supply in the Theory of
Liquidity Preference.
4
Turn to the derivation .of LM.
Fig. 10-12, p. 275. Deriving the LM Curve
Fig. 11-11, p. 321. Deriving the LM
Curve
Fig. 10-13, p. 276. Reduction of the Money
Supply Shifts the LM Curve Upward.
Fig. 11-12, p. 322. Reduction of the
Money Supply Shifts the LM Curve
Upward.
Mentions Volcker’s tight Money
policy
Fig. 10-14, p. 277. Equilibrium in the IS-LM Model
Fig. 10-15, p. 278. The Theory of Short Run Fluctuations.
Fig. 11-13, p. 323. Equilibrium in
the IS-LM Model
Fig. 11-14, p. 324. The Theory of
Short Run Fluctuations.