This document contains lecture slides on the Keynesian system and policy effects in the IS-LM model. It discusses how increasing the money supply shifts the LM curve to the right, increasing output. It also examines how an increase in government spending shifts the IS curve to the right, raising output. The document analyzes the effects of increasing taxes or falling investment, which shift the IS curve left, reducing output. The slides explore the effectiveness of monetary and fiscal policy depending on the responsiveness of investment and money demand. Finally, it introduces the Keynesian theory of inflation.

1. TThhee KKeeyynneessiiaann SSyysstteemm IIIIII::
PPoolliiccyy EEffffeeccttss iinn tthhee IISS--LLMM MMooddeell
CChhaapptteerr 88
Professor Steve Cunningham
Intermediate Macroeconomics
ECON 219

2. IInnccrreeaassiinngg tthhee MMoonneeyy SSuuppppllyy
0 Ms
r 1
2
LM(M1)
IS
LM(Mr 0)
r0
r1
Md
Ms
r0
r1
Y0 Y1 M

3. IInnccrreeaassee iinn GGoovv’’tt SSppeennddiinngg
3
IS(G1)
IS(G0) LM
r
r1
r0
Y0 Y1
Recall that:
Y = C + I + G + NX.
When G¯ then Y¯.

4. 4
AS
AD2
Y
Nd Y=F(N,K)
w0
P
w/p
N
AD0
AD1
N­
Y­
AD­
NOTES:
1. G rises, increasing
AD.
2. Employment and
output result from
AD increases.
3. Prices (P) also rise.
4. As prices rise, the
real wages fall,
making labor more
attractive.
5. As more workers are
employed, and
unemployment falls.
(w/p)¯

5. 5
IInnccrreeaassee iinn TTaaxxeess
r
IS(T0)
LM IS(T1) LM
r0
r1
Y1 Y0
Recall that:
Y = C + I + G + NX.
When T­ then Yd¯,
and so must C¯ and Y¯.

6. 6
IInnvveessttmmeenntt FFaallllss
IS(I0)
IS(I1) LM
r
r0
r1
Y1 Y0
Recall that:
Y = C + I + G + NX.
When I¯ then Y¯.

7. 7
AS
AD0
Y
Nd Y=F(N,K)
w0
P
w/p
N
AD2
AD1
N¯
Y¯
AD¯
NOTES:
1. Rising taxes or
falling investment
reduces AD.
2. Final sales and
output (Y) fall.
3. As prices fall, the
real wages rise,
making labor more
expensive to firms.
4. Firms require fewer
workers to build
products and find
workers more
expensive, so they lay
off workers.
5. Unemployment rises.
(w/p)­

8. Monetary PPoolliiccyy EEffffeeccttiivveenneessss
8
r r
Investment not responsive to
interest rate changes
LM1
Investment is responsive to
interest rate changes
IS
LM IS 1
LM2
LM2
? Y Y

9. IS1 IS2
9
FFiissccaall PPoolliiccyy EEffffeeccttiivveenneessss
IS1
r r
Money demand is responsive
to interest rate changes
LM
LM
Y ? Y
IS2
Money demand not
responsive to interest rate
changes

10. KKeeyynneessiiaann TThheeoorryy ooff IInnffllaattiioonn
10
P AS
Y
Keynesian or
Depression Region
Classical
Region
Bottleneck
Region
AD1
AD2 AD3
AD4 AD5
AD6
Y­
P­
DP=0
Y­
P­
DY=0