Chapter 10 Aggregate Demand I

Transcription

1 Chapte 10 Aggegate Demand I CHAPTER 10 0 CHAPTER 10 1 Leaning Objectives Chapte 9 intoduced the model of aggegate demand and aggegate supply. Long un (Classical Theoy) pices flexible output detemined by factos of poduction & technology unemployment equals its natual ate Shot un (Keynes) pices fixed output detemined by aggegate demand unemployment is negatively elated to output CHAPTER

2 Leaning Objectives This chapte develops the IS-LM model (Hicks), the theoy that yields the aggegate demand cuve. We focus on the shot un and assume the pice level is fixed. CHAPTER 10 3 The Big Pictue Keynesian Coss Theoy of Liquidity Pefeence IS cuve LM cuve IS-LM model Explanation of shot-un fluctuations Agg. demand cuve Agg. supply cuve Model of Agg. Demand and Agg. Supply CHAPTER The IS Cuve 1.1 The Keynesian Coss A simple closed economy model in which income is detemined by expenditue. (due to Keynes) Notation: E = C + I + G = planned expenditue = eal GDP = actual expenditue Diffeence between actual & planned expenditue: unplanned inventoy investment CHAPTER

3 1.1 The Keynesian Coss consumption function: govt policy vaiables: fo now, investment is exogenous: planned expenditue: C = C ( T ) G = G, T = T I = I E = C ( T ) + I + G Equilibium condition: Actual expenditue = = Planned expenditue E CHAPTER The Keynesian Coss Planned Expenditue E planned expenditue E =C +I +G 1 MPC income, output, CHAPTER The Keynesian Coss Equilibium Condition E planned E = expenditue 45º income, output, CHAPTER

4 1.1 The Keynesian Coss E planned expenditue E = E =C +I +G Equilibium income income, output, CHAPTER The Keynesian Coss An incease in govenment puchases At 1, thee is now an unplanned dop in inventoy G E E = E =C +I +G 2 E =C +I +G 1 so fims incease output, and income ises towad a new equilibium E 1 = 1 E 2 = 2 CHAPTER The Keynesian Coss An incease in govenment puchases = C + I + G = C + I + G = C + G = MPC + G equilibium condition in changes because I exogenous b.c. C = MPC ( - T) Collect tems with on the left side of the equals sign: (1 MPC) = G Finally, solve fo : 1 = G 1 MPC CHAPTER

5 1.1 The Keynesian Coss The govenment puchases multiplie Definition: the incease in income esulting fom a 1unit incease in G. In this model, the G multiplie equals G = 1 1 MPC CHAPTER The Keynesian Coss The govenment puchases multiplie Example: MPC = = G 1 MPC 1 1 = G = G = 5 G The incease in G causes income to incease by 5 times as much! G 1 = = CHAPTER The Keynesian Coss The govenment puchases multiplie Why is the multiplie geate than 1? Initially, the incease in G causes an equal incease in : = G. But C futhe futhe C futhe So the final impact on income is much bigge than the initial G. CHAPTER

6 1.1 The Keynesian Coss An incease in taxes Initially, the tax incease educes consumption, and theefoe E: E E = E =C 1 +I +G E =C 2 +I +G C = MPC T so fims educe output, and income falls towad a new equilibium E 2 = 2 At 1, thee is now an unplanned inventoy buildup E 1 = 1 CHAPTER The Keynesian Coss An incease in taxes = C + I + G = C = MPC ( T ) Solving fo : eq m condition in changes I and G exogenous (1 MPC) = MPC T Final esult: MPC = T 1 MPC CHAPTER The Keynesian Coss The tax multiplie Definition: the change in income esulting fom a 1unit incease in T : T MPC = 1 MPC If MPC = 0.8, then the tax multiplie equals = = = 4 T CHAPTER

7 1.1 The Keynesian Coss The tax multiplie is negative: An incease in taxes educes consume spending, which educes equilibium income. is geate than one (in absolute value): A change in taxes has a multiplie effect on income. is smalle than the govt spending multiplie: Consumes save the faction (1-MPC) of a tax cut, so the initial boost in spending fom a tax cut is smalle than fom an equal incease in G. CHAPTER Defining and Deiving the IS Cuve Using Keynesian Coss and Investment Function Definition: a gaph of all combinations of and that esult in goods maket equilibium, i.e. actual expenditue (output) = planned expenditue The equation fo the IS cuve is: = C ( T ) + I ( ) + G CHAPTER Defining and Deiving the IS Cuve Using Keynesian Coss and Investment Function E E = E =C +I( 2 )+G I E =C +I( 1 )+G E I IS CHAPTER

8 1.2 Defining and Deiving the IS Cuve Using Loanable Funds Appoach (a) The L.F. model S 2 S 1 (b) The IS cuve I( ) S, I IS CHAPTER Defining and Deiving the IS Cuve The IS cuve is negatively sloped. Intuition: A fall in the inteest ate motivates fims to incease investment spending, which dives up total planned spending (E ). To estoe equilibium in the goods maket, output (a.k.a. actual expenditue, ) must incease. CHAPTER Fiscal Policy and the IS Cuve We can use the IS-LM model to see how fiscal policy (G and T ) can affect aggegate demand and output. Let s stat by using the Keynesian Coss to see how fiscal policy shifts the IS cuve CHAPTER

9 1.3 Fiscal Policy and the IS Cuve At any value of, G E so the IS cuve shifts to the ight. The hoizontal distance of the IS shift equals 1 = G 1 MPC E E = E =C +I( 1 )+G IS 1 E =C +I( 1 )+G 1 CHAPTER IS 2 2. The LM Cuve 2.1 The Theoy of Liquidity Pefeence A simple theoy in which the inteest ate is detemined by money supply and money demand. (due to Keynes again) CHAPTER The Theoy of Liquidity Pefeence The supply of eal money balances is fixed: ( M P ) s = M P inteest ate ( M P ) s M P M/P eal money balances CHAPTER

10 2.1 The Theoy of Liquidity Pefeence Demand fo eal money balances: d ( M P ) = L( ) inteest ate ( M P ) s L() M P M/P eal money balances CHAPTER The Theoy of Liquidity Pefeence The inteest ate adjusts to equate the supply and demand fo money: M P L( ) inteest ate 1 ( M P ) s = L() M P M/P eal money balances CHAPTER The Theoy of Liquidity Pefeence A change in money supply To incease, Fed educes M inteest ate 2 1 L() M 2 P M 1 P M/P eal money balances CHAPTER

11 2.2 Defining and Deiving the LM Cuve Using Theoy of Liquidity Pefeence Now let s put back into the money demand function: = L(, ) ( M P ) d The LM cuve is a gaph of all combinations of and that equate the supply and demand fo eal money balances. The equation fo the LM cuve is: M P = L(, ) CHAPTER Defining and Deiving the LM Cuve Using Theoy of Liquidity Pefeence (a) The maket fo (b) The LM cuve eal money balances LM 2 1 M 1 P L(, 2 ) L(, 1 ) M/P CHAPTER Defining and Deiving the LM Cuve Using Quantity Equation Quantity Equation MV=P Quantity Theoy of money assumes constant velocity vetical LM cuve If we adjust it so that V=V() then we get the upwad sloping LM cuve again. CHAPTER

12 2.2 Defining and Deiving the LM Cuve The LM cuve is positively sloped. Intuition: An incease in income aises money demand. Since the supply of eal balances is fixed, thee is now excess demand in the money maket at the initial inteest ate. The inteest ate must ise to estoe equilibium in the money maket. CHAPTER Monetay Policy and the LM Cuve (a) The maket fo eal money balances (b) The LM cuve LM LM 1 1 L(, 1 ) 1 M 2 P M 1 P M/P 1 CHAPTER The shot-un equilibium The shot-un equilibium is the combination of and that simultaneously satisfies the equilibium conditions in the goods & money makets: = C ( T ) + I ( ) + G M P = L(, ) Equilibium inteest ate LM IS Equilibium level of income CHAPTER

13 Chapte summay 1. Keynesian Coss basic model of income detemination takes fiscal policy & investment as exogenous fiscal policy has a multiplied impact on income. 2. IS cuve comes fom Keynesian Coss when planned investment depends negatively on inteest ate shows all combinations of and that equate planned expenditue with actual expenditue on goods & sevices CHAPTER Chapte summay 3. Theoy of Liquidity Pefeence basic model of inteest ate detemination takes money supply & pice level as exogenous an incease in the money supply lowes the inteest ate 4. LM cuve comes fom Liquidity Pefeence Theoy when money demand depends positively on income shows all combinations of and that equate demand fo eal money balances with supply CHAPTER Chapte summay 5. IS-LM model Intesection of IS and LM cuves shows the unique point (, ) that satisfies equilibium in both the goods and money makets. CHAPTER

14 Peview of Chapte 11 In Chapte 11, we will use the IS-LM model to analyze the impact of policies and shocks lean how the aggegate demand cuve comes fom IS-LM use the IS-LM and AD-AS models togethe to analyze the shot-un and longun effects of shocks lean about the Geat Depession using ou models CHAPTER