Recommended
Recommended
More Related Content
What's hot
What's hot (20)
Similar to Aggregate demand ii
Similar to Aggregate demand ii (20)
More from Abd ELRahman ALFar
More from Abd ELRahman ALFar (20)
Recently uploaded
Recently uploaded (20)
Aggregate demand ii
- 1. MMACROECONOMICSACROECONOMICS C H A P T E R © 2007 Worth Publishers, all rights reserved SIXTH EDITIONSIXTH EDITION PowerPointPowerPoint®® Slides by Ron CronovichSlides by Ron Cronovich NN.. GGREGORYREGORY MMANKIWANKIW Aggregate Demand II: Applying the IS -LM Model 11
- 2. slide 2CHAPTER 11 Aggregate Demand II Context Chapter 9 introduced the model of aggregate demand and supply. Chapter 10 developed the IS-LM model, the basis of the aggregate demand curve.
- 3. slide 3CHAPTER 11 Aggregate Demand II In this chapter, you will learn… how to use the IS-LM model to analyze the effects of shocks, fiscal policy, and monetary policy how to derive the aggregate demand curve from the IS-LM model several theories about what caused the Great Depression
- 4. slide 4CHAPTER 11 Aggregate Demand II The intersection determines the unique combination of Y and r that satisfies equilibrium in both markets. The LM curve represents money market equilibrium. Equilibrium in the IS -LM model The IS curve represents equilibrium in the goods market. ( ) ( )Y C Y T I r G= − + + ( , )M P L r Y= IS Y r LM r1 Y1
- 5. slide 5CHAPTER 11 Aggregate Demand II Policy analysis with the IS -LM model We can use the IS-LM model to analyze the effects of • fiscal policy: G and/or T • monetary policy: M ( ) ( )Y C Y T I r G= − + + ( , )M P L r Y= IS Y r LM r1 Y1
- 6. slide 6CHAPTER 11 Aggregate Demand II causing output & income to rise. IS1 An increase in government purchases 1. IS curve shifts right Y r LM r1 Y1 1 by 1 MPC G∆ − IS2 Y2 r2 1. 2. This raises money demand, causing the interest rate to rise… 2. 3. …which reduces investment, so the final increase in Y 1 is smaller than 1 MPC G∆ − 3.
- 7. slide 7CHAPTER 11 Aggregate Demand II IS1 1. A tax cut Y r LM r1 Y1 IS2 Y2 r2 Consumers save (1−MPC) of the tax cut, so the initial boost in spending is smaller for ∆T than for an equal ∆G… and the IS curve shifts by MPC 1 MPC T − ∆ − 1. 2. 2.…so the effects on r and Y are smaller for ∆T than for an equal ∆G. 2.
- 8. slide 8CHAPTER 11 Aggregate Demand II 2. …causing the interest rate to fall IS Monetary policy: An increase in M 1. ∆M > 0 shifts the LM curve down (or to the right) Y r LM1 r1 Y1 Y2 r2 LM2 3. …which increases investment, causing output & income to rise.
- 9. slide 9CHAPTER 11 Aggregate Demand II Interaction between monetary & fiscal policy Model: Monetary & fiscal policy variables (M, G, and T) are exogenous. Real world: Monetary policymakers may adjust M in response to changes in fiscal policy, or vice versa. Such interaction may alter the impact of the original policy change.
- 10. slide 10CHAPTER 11 Aggregate Demand II The Fed’s response to ∆G > 0 Suppose Congress increases G. Possible Fed responses: 1. hold M constant 2. hold r constant 3. hold Y constant In each case, the effects of the ∆G are different:
- 11. slide 11CHAPTER 11 Aggregate Demand II If Congress raises G, the IS curve shifts right. IS1 Response 1: Hold M constant Y r LM1 r1 Y1 IS2 Y2 r2 If Fed holds M constant, then LM curve doesn’t shift. Results: 2 1Y Y Y∆ = − 2 1r r r∆ = −
- 12. slide 12CHAPTER 11 Aggregate Demand II If Congress raises G, the IS curve shifts right. IS1 Response 2: Hold r constant Y r LM1 r1 Y1 IS2 Y2 r2 To keep r constant, Fed increases M to shift LM curve right. 3 1Y Y Y∆ = − 0r∆ = LM2 Y3 Results:
- 13. slide 13CHAPTER 11 Aggregate Demand II IS1 Response 3: Hold Y constant Y r LM1 r1 IS2 Y2 r2 To keep Y constant, Fed reduces M to shift LM curve left. 0Y∆ = 3 1r r r∆ = − LM2 Results: Y1 r3 If Congress raises G, the IS curve shifts right.
- 14. slide 14CHAPTER 11 Aggregate Demand II Shocks in the IS -LM model IS shocks: exogenous changes in the demand for goods & services. Examples: stock market boom or crash ⇒ change in households’ wealth ⇒ ∆C change in business or consumer confidence or expectations ⇒ ∆I and/or ∆C
- 15. slide 15CHAPTER 11 Aggregate Demand II Shocks in the IS -LM model LM shocks: exogenous changes in the demand for money. Examples: a wave of credit card fraud increases demand for money. more ATMs or the Internet reduce money demand.
- 16. slide 16CHAPTER 11 Aggregate Demand II EXERCISE: Analyze shocks with the IS-LM model Use the IS-LM model to analyze the effects of 1. a boom in the stock market that makes consumers wealthier. 2. after a wave of credit card fraud, consumers using cash more frequently in transactions. For each shock, a. use the IS-LM diagram to show the effects of the shock on Y and r. b. determine what happens to C, I, and the unemployment rate.
Editor's Notes
- This is a very substantial chapter, and among the most challenging in the text. I encourage you to go over this chapter a little more slowly than average, or at least recommend to your students that they study it extra carefully. I have included a number of in-class exercises to give students immediate reinforcement of concepts as they are covered, and also to break up the lecture. If you need to get through the material more quickly, you can omit some or all of these exercises (perhaps assigning them as homeworks, instead). A graph unfolds on slides 29-33. If you create handouts of this file for your students (or create a PDF version for them to download from the web), you might consider omitting slides 30 and 32 to save paper, as they contain intermediate animations.
- Review/recap of the very end of Chapter 10.
- Chapter 10 showed that an increase in G causes the IS curve to shift to the right by (G)/(1-MPC).
- Chapter 10 used the Keynesian Cross to show that a decrease in T causes the IS curve to shift to the right by (-MPCT)/(1-MPC). If your students ask why the IS curve shifts to the right when there’s a negative sign in the expression for the shift, remind them that T < 0 for a tax cut, so the expression actually is positive. The term showing the distance of the shift in the IS curve is almost the same as in the case of a government spending increase, where the numerator of the fraction equals (1) for government spending rather than (-MPC) for the tax cut. Here’s the intuition: Every dollar of a government spending increase adds to aggregate spending. However, for tax cuts, the fraction (1-MPC) of the tax cut leaks into saving, so aggregate spending only rises by MPC times the tax cut.
- Chapter 10 showed that an increase in M shifts the LM curve to the right. Here is a richer explanation for the LM shift: The increase in M causes the interest rate to fall. [People like to keep optimal proportions of money and bonds in their portfolios; if money is increased, then people try to re-attain their optimal proportions by “exchanging” some of the money for bonds: they use some of the extra money to buy bonds. This increase in the demand for bonds drives up the price of bonds -- and causes interest rates to fall (since interest rates are inversely related to bond prices). The fall in the interest rate induces an increase in investment demand, which causes output and income to increase. The increase in income causes money demand to increase, which increases the interest rate (though doesn’t increase it all the way back to its initial value; instead, this effect simply reduces the total decrease in the interest rate).
- Earlier slides showed how to use the IS-LM model to analyze fiscal and monetary policy. Now is a good time for students to get some hands-on practice with the model. Also, note that part (b) helps students learn that shocks and policies can potentially affect all of the model’s endogenous variables, not just the ones that are measured on the axes. After working this exercise, your students will better understand the case study on the 2001 U.S. recession that immediately follows. Suggestion: Instead of having students work on these exercises individually, get them into pairs. One student of each pair works on the first shock, the other student works on the second shock. Give them 5 minutes to work individually on the analysis of the shock. Then, allow 10 minutes (5 for each student) for students to present their results to their partners. This activity gives students immediate application and reinforcement of the concepts, so students learn them better and will then better understand and appreciate the remainder of your lecture on Chapter 11. Answers: 1a. The IS curve shifts to the right, because consumers feel they can afford to spend more given this exogenous increase in their wealth. This causes Y and r to rise. 1b. C rises for two reasons: the stock market boom, and the increase in income. I falls, because r is higher. u falls, because firms hire more workers to produce the extra output that is demanded. 2a. (This is a continuation of the in-class exercise at the end of the PowerPoint presentation of Chapter 10.) The increase in money demand shifts the LM curve to the left: We are assuming that all other exogenous variables, including M and P, remain unchanged, so an increase in money demand causes an increase in the value of r associated with each value of Y (this can be seen easily using the Liquidity Preference diagram). This translates to an upward (i.e. leftward) shift in the LM curve. This shift causes Y to fall and r to rise. 2b. The fall in income causes a fall in C. The increase in r causes a fall in I. The fall in Y causes an increase in u.