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.