Aggregate Demand I: Building the IS-LM Model
Chapter 11 of Macroeconomics, 8th edition, by N. Gregory Mankiw
ECO62 Udayan Roy
THE GOODS MARKET IN THE SHORT RUN
Recap: Long-Run Theory of Output
Actual Output ≠ Potential Output
Short-Run Theory of Output: it’s all about demand
• The short-run theory of total real GDP is also called– Keynesian theory, after the economist John
Maynard Keynes, or – Aggregate Demand Theory
• This theory assumes that, in the short run, output is determined by aggregate demand: the economy will produce as much output as there is demand for
THE KEYNESIAN CROSSThe simplest theory of short-run equilibrium in the goods market
Planned Expenditure• Assumption: The economy is a closed
economy• Planned Expenditure (PE) is the total desired
expenditure of the three sectors of the economy:– Households (C)– Businesses (I) and– Government (G)
• PE = C + I + G
Consumption Expenditure
• PE = C + I + G• What determines the planned expenditure of
households (C)?– We did this before in chapter 3
Consumption, C
Consumption, C• Assumption: Planned expenditure by households is
directly related to disposable income
• Consumption function: C = C (Y – T )
Consumption Function: algebra• Consumption function: C = C (Y – T )
• Specifically, C = Co + Cy✕(Y – T)
• Co represents all other exogenous variables that affect consumption, such as asset prices, consumer optimism, etc.
• Cy is the marginal propensity to consume (MPC), the fraction of every additional dollar of income that is consumed
Consumption Function: graphC
Y – T
C (Y –T) = Co + Cy✕(Y – T)
1
MPCThe slope of the consumption function is the MPC.
Marginal propensity to consume (MPC) is the increase in consumption (C) when disposable income (Y – T) increases by one dollar. It is also Cy.
Co
Consumption Function: shiftsC
Y – T
C = Co1 + Cy✕(Y – T)
C = Co2 + Cy✕(Y – T)
Consumption shift factor: greater consumer optimism, higher asset prices (Co↑)
F(K, L) – T1 F(K, L) – T2
T1 > T2
Consumption Function: example
• Suppose Y = 30.85 and T = 0.85. • Therefore, disposable income is Y – T = 30. • Now, suppose C = 2 + 0.8 ✕ (Y – T). • Then, C = 2 + 0.8 ✕ 30 = 26
Y
C(Y – T), T
C
Private Saving is defined as disposable income – consumption, which is Y – T – C = 30 – 26 = 4.
Income and Private Saving
• The marginal propensity to consume is a positive fraction (0 < MPC < 1)
• That is, when income (Y) increases, consumption (C) also increases, but by only a fraction of the increase in income.
• Therefore, Y↑⇒ C↑ and Y – C↑ and Y – T – C↑
• Similarly, Y↓⇒ C↓ and Y – C↓ and Y – T – C↓
Planned Investment
• PE = C + I + G• Assumption: Planned investment spending by
businesses (I) is exogenous
• This assumption is a big deal. • Recall that business investment was
endogenous in long-run analysis of chapters 3, 8 and 9.
Government Spending
• PE = C + I + G• Assumption: government spending (G) is
exogenous• Public Saving is defined as the net tax revenue
of the government minus government spending, which is T – G – This is also called the budget surplus
Planned Expenditure
• PE = C + I + G• Therefore, PE = C(Y – T) + I + G• Or, more specifically, PE = Co + Cy✕(Y – T) + I +
G
Equilibrium
• Assumption: The goods market will be in equilibrium. That is, actual expenditure will be equal to planned expenditure.
Actual and planned expenditure
• Actual and planned expenditure do not have to be equal in all circumstances
• Actual expenditure = planned expenditure + unplanned increase in inventory– When unplanned increase in inventory > 0, more
is bought than was intended. – When unplanned increase in inventory < 0, less is
bought than was intended.
Equilibrium
• When unplanned increase in inventory > 0, more is bought than was intended.
• So, actual expenditure > planned expenditure• In this case, output will shrink• In other words, the current output level
cannot represent equilibrium
Equilibrium
• When unplanned increase in inventory < 0, less is bought than was intended.
• So, actual expenditure < planned expenditure• In this case, output will increase• In other words, the current output level
cannot represent equilibrium
Equilibrium
• For an economy to be in equilibrium, unplanned increase in inventory must be zero
• Therefore, actual expenditure = planned expenditure + unplanned increase in inventory = planned expenditure
• But recall that actual expenditure is actual GDP or Y, and planned expenditure is C + I + G
• Therefore, in equilibrium, Y = C + I + G
Short-Run GDP: calculation
• We just saw that in equilibrium Y = C + I + G• Therefore, Y = Co + Cy ✕ (Y – T) + I + G
• This is one equation with one unknown, Y• So, this equation can be used to solve for Y
– Example: C = 2 + 0.8✕(Y – T), T = 0.85, G = 3, and I = 1.85
– Then, Y = 2 + 0.8✕(Y – 0.85) + 1.85 + 3– Check that Y = 30.85
Short-Run GDP: calculation
• In equilibrium, Y = C + I + G
y
yo
yoy
yoy
yyo
yo
C
GITCCY
GITCCYC
GITCCYCY
GITCYCCY
GITYCCY
1
)1(
)(
Every variable on the right hand-side of the equation is exogenous. So, this equation tells us everything we can say about Y in the Keynesian Cross model.
At this point, you should be able to do problems 2 and 4 on pages 325-26 of the textbook. Please try them.
Short-Run GDP: predictions
y
yo
C
GITCCY
1
Every variable on the right hand-side of the equation is exogenous. So, this equation tells us everything we can say about Y in the Keynesian Cross model.
Predictions Grid
Y
Co +
T −
I +
G +
In other words, the Keynesian Cross model is able to explain why recessions and booms happen.
The Keynesian Cross Equation
TC
CGIC
CC
GITCCY
y
yo
yy
yo
1)(
1
1
1
The Spending Multiplier
• Note that for every $1.00 increase in Co + I + G, Y increases by $1/(1 – Cy).
• As Cy is the marginal propensity to consume, 1/(1 – Cy) may be written as 1/(1 – MPC).
• This is called the spending multiplier.
TC
CGIC
CY
y
yo
y
1
)(1
1
The Spending Multiplier
• As the marginal propensity to consume is a positive fraction (0 < MPC < 1), 1 – MPC is also a positive fraction.
• Therefore, 1/(1 – MPC) > 1.• So, for every $1.00 increase in Co + I + G, Y
increases by more than $1.00!
TC
CGIC
CY
y
yo
y
1
)(1
1
The Spending Multiplier
• The spending multiplier is 1/(1 – MPC).• Example: If MPC = 0.2, the spending multiplier = 1/(1 – 0.2)
= 1.25. Therefore, if the government spends $3 billion on a new highway, real GDP will increase by $3.75 billion
• Example: If MPC = 0.8, the spending multiplier = 1/(1 – 0.8) = 5. Therefore, if the government spends $3 billion on a new highway, real GDP will increase by $15 billion
• The bigger MPC is, the bigger the spending multiplier will be. Why???
TC
CGIC
CY
y
yo
y
1
)(1
1
The Tax-Cut Multiplier
• Note that for every $1.00 decrease in T, Y increases by $Cy/(1 – Cy).
• As Cy is the marginal propensity to consume, Cy
/(1 – Cy) may be written as MPC/(1 – MPC).
• This is the tax-cut multiplier.
TC
CGIC
CY
y
yo
y
1
)(1
1
The Tax-Cut Multiplier
• As the marginal propensity to consume is a positive fraction (0 < MPC < 1), – MPC/(1 – MPC) < 1/(1 – MPC) – Tax-cut multiplier < spending multiplier– That is, a $1.00 tax cut provides a smaller boost to
the economy than a $1.00 increase in government spending. Why??
TC
CGIC
CY
y
yo
y
1
)(1
1
At this point, you should be able to do problem 1 on page 325 of the textbook. Please try it.
The Tax-Cut Multiplier
• The tax-cut multiplier is MPC/(1 – MPC).• Example: If MPC = 0.2, the tax-cut multiplier = 0.2/(1 –
0.2) = 0.25 < 1. Therefore, if the government cuts taxes by $3 billion, real GDP will increase by $0.75 billion
• Example: If MPC = 0.8, the tax-cut multiplier = 0.8/(1 – 0.8) = 4. Therefore, if the government cuts taxes by $3 billion, real GDP will increase by $12 billion
TC
CGIC
CY
y
yo
y
1
)(1
1
Fiscal Policy
• The practice of changing the levels of government spending (G) and/or taxes (T) in order to affect the macroeconomic outcome is called fiscal policy– Spending more (G↑) and/or cutting taxes (T↓) is
called expansionary fiscal policy– Spending less (G↓) and/or raising taxes (T↑) is
called contractionary fiscal policy
Fiscal Policy
• The consequences of expansionary and contractionary fiscal policy in the Keynesian Cross model were analyzed in previous slides
• In any case, they can be easily seen from the Keynesian Cross model’s equation:
TC
CGIC
CY
y
yo
y
1
)(1
1
K.C. Spending multiplier
K.C. Tax-cut multiplier
Fiscal Policy: balanced budget multiplier
• Note that expansionary fiscal policy (G↑ and/or T↓) leads to lower public saving (T – G↓) – This could mean a rise in the budget deficit or a
fall in the budget surplus
• Is there no way to stimulate an economy in a recession while keeping the budget balanced?
• There is!
Fiscal Policy: balanced budget multiplier
Fiscal Policy: balanced budget multiplier
• The balanced budget multiplier shows that if both government spending and taxes are increased by the same amount—thereby keeping the budget balanced—then output will increase by the same amount.
Graphing planned expenditure
income, output, Y
PE
planned
expenditure
PE =C +I +G
MPC1
Graphing the equilibrium condition
income, output, Y
PE
planned
expenditure
PE =Y
45º
The equilibrium value of income
Y
PE
planned
expenditure
PE =Y
PE =C +I +G
Equilibrium income
Output gap
An increase in government purchases
Y
PE
PE =
Y
PE =C +I +G1
PE1 = Y1
PE =C +I +G2
PE2 = Y2
Y
At Y1,
there is now an unplanned drop in inventory…
…so firms increase output, and income rises toward a new equilibrium.
G
Solving for YY C I G
Y C I G
MPC Y G
C G
(1 MPC) Y G
1
1 MPC
Y G
equilibrium condition
in changes
because I exogenous
because C = MPC
Y
Collect terms with Y on the left side of the equals sign:
Solve for Y :
The government purchases multiplier
Example: If MPC = 0.8, then
Definition: the increase in income resulting from a $1 increase in G.In this model, the govt purchases multiplier equals
1
1 MPC
YG
15
1 0.8
YG
An increase in G causes income to increase 5 times
as much!
An increase in G causes income to increase 5 times
as much!
Why the multiplier is greater than 1
• Initially, the increase in G causes an equal increase in Y: Y = G.
• But Y C further Y further C further Y
• So the final impact on income is much bigger than the initial G.
An increase in taxes
Y
PE
PE
=Y
PE =C2 +I +G
PE2 = Y2
PE =C1 +I +G
PE1 = Y1
Y
At Y1, there is now
an unplanned inventory buildup……so firms
reduce output, and income falls toward a new equilibrium
C = MPC T
Initially, the tax increase reduces consumption, and therefore PE:
Solving for YY C I G
MPC Y T
C
(1 MPC) MPC Y T
eq’m condition in changes
I and G exogenous
Solving for Y :
MPC
1 MPC
Y TFinal result:
The tax multiplierdef: the change in income resulting from a $1 increase in T :
MPC
1 MPC
YT
0.8 0.84
1 0.8 0.2
YT
If MPC = 0.8, then the tax multiplier equals
The tax multiplier…is negative: A tax increase reduces C, which reduces income.
…is smaller than the spending multiplier: Consumers save the fraction (1 – MPC) of a tax cut, so the initial boost in spending from a tax cut is smaller than from an equal increase in G (or Co or Io).
NOW YOU TRY:
Practice with the Keynesian Cross
• Use a graph of the Keynesian cross to show the effects of an increase in planned investment on the equilibrium level of income/output.
Tax Cuts: JFK
• Kennedy cut personal and corporate income taxes in 1964
• An economic boom followed. – GDP grew 5.3% in 1964 and 6.0 in 1965. – Unemployment fell from 5.7% in 1963 to 5.2% in 1964
to 4.5% in 1965.• However, it is not easy to prove that the tax cuts
caused the boom• Even when they agree that the tax cuts caused
the boom, economists can’t agree on the reason
Tax Cuts: JFK
• Keynesians argued that the tax cuts boosted demand, which led to higher production and falling unemployment
• Supply-siders argued that demand had nothing to do with it. The tax cuts gave people the incentive to work harder. So, L increased. Therefore, Y = F(K, L) also increased.– Personally, I feel this argument doesn’t explain
why the unemployment rate fell
Tax Cuts: GWB• Bush cut taxes in 2001 and 2003• After the second tax cut, a weak recovery from
the 2001 recession turned into a strong recovery– GDP grew 4.4% in 2004– Unemployment fell from its peak of 6.3% in June 2003
to 5.4% in December 2004• In justifying his tax cut, Bush used the Keynesian
explanation: – “When people have more money, they can spend it
on goods and services. … when they demand an additional good or service, somebody will produce the good or service.”
Spending Stimulus: Barack Obama
• When President Obama took office in January 2009, the economy had suffered the worst collapse since the Great Depression
• Obama helped enact an $800 billion (5% of annual GDP) stimulus to be spent over a two-year period
• About 40% was tax cuts, and 60% was additional government spending– White House economists had estimated the
spending multiplier to be 1.57 and the tax-cut multiplier to be 0.99
Spending Stimulus: Barack Obama
• Much of the new spending was on infrastructure projects
• These projects were fine for the long run, but took a long time to be implemented, and were therefore not ideal as a short-run boost
• Obama publicly justified his stimulus bill using Keynesian demand-side reasoning
THE IS CURVE
A slightly more complex theory of short-run equilibrium in the goods market
Planned Investment
• The Keynesian Cross model assumed that planned expenditure by businesses (I) is exogenous
• Recall that, in chapter 3, we had assumed that investment spending is inversely related to the real interest rate
• The IS Curve theory of the goods market brings back the investment function I = I(r)
The Real Interest Rate
• Recall from chapter 3 that, the real interest rate is the inflation-adjusted interest rate
• To adjust the nominal interest rate for inflation, you simply subtract the inflation rate from the nominal interest rate– If the bank charges you 5% interest rate on a cash
loan, that’s the nominal interest rate (i = 0.05). – If the inflation rate turns out to be 3% during the
loan period (π = 0.03), then you paid the real interest rate of just 2% (r = i − π = 0.02)
The Real Interest Rate
• The problem is that when you are taking out a loan you don’t quite know what the inflation rate will be over the loan period
• So, economists distinguish between– the ex post real interest rate: r = i − π– and the ex ante real interest rate: r = i − Eπ,
where Eπ is the expected inflation rate over the loan period
– We will use the ex ante interpretation of the real interest rate
Investment and the real interest rate
• Assumption: investment spending is inversely related to the real interest rate
• I = I(r), such that r↑⇒ I↓r
I
I (r )
Investment and the real interest rate
• Specifically, I = Io − Irr• Here Ir is the effect of r
on I and • Io represents all other
factors that also affect business investment spending – such as business
optimism, technological progress, etc.
I
r
Io1 − Irr
Io2 − Irr
Investment: example
• Suppose I = 11.85 – 2r is the investment function
• Then, if r = 5 percent, we get I = 11.85 – 2r = 1.85.
The IS Curve
• Recall that the goods market is in equilibrium when Y = C + I + G
• The IS curve is a graph that shows all combinations of r and Y for which the goods market is in equilibrium
• Therefore, the basic equation underlying the IS curve is Y = C(Y – T) + I(r) + G
Deriving the IS Curve: algebra
rC
IT
C
CGIC
CY
GrIITCCYC
GrIITCCYCY
GrIITCYCCY
GrIITYCCY
GrITYCY
y
r
y
yoo
y
royoy
royoy
royyo
royo
11)(
1
1
)1(
)(
)()(
K.C. Spending multiplier
K.C. Tax-cut multiplier
IS Interest rate effect
Deriving the IS Curve: algebra
rC
IT
C
CGIC
CY
y
r
y
yoo
y
11
)(1
1
So, although the basic equation underlying the IS curve is …
GrITYCY )()(
… for my specific consumption and investment functions, the equation underlying the IS curve can also be expressed as:
The two equations are equivalent forms of the IS curve.
Comparing the Equations of the Keynesian Cross and the IS Curve
rC
IT
C
CGIC
CY
y
r
y
yoo
y
11
)(1
1
TC
CGIC
CY
y
yoo
y
1
)(1
1
Keynesian Cross
IS Curve
K.C. Spending multiplier
K.C. Tax-cut multiplier
IS Interest rate effect
K.C. Spending multiplier
K.C. Tax-cut multiplier
This is the only difference
The IS Curve
rC
IT
C
CGIC
CY
y
r
y
yoo
y
11
)(1
1
K.C. Spending multiplier
K.C. Tax-cut multiplier
IS Interest rate effect
Y2Y1
r
Y
r1
ISr2
ΔY
Δr
Any change in the real interest rate will cause an opposite change in real total GDP by a multiple determined by the size of the interest rate effect.
This is why the IS curve is negatively sloped.
The IS Curve: effect of fiscal policy
rC
IT
C
CGIC
CY
y
r
y
yoo
y
11
)(1
1
K.C. Spending multiplier
K.C. Tax-cut multiplier
IS Interest rate effect
Y2Y1
r
Y
r1
IS1IS2
Y
Any increase in Co + Io + G causes the IS curve to shift right by an amount magnified by the Keynesian Cross spending multiplier
That is, if the real interest rate is unchanged, the Keynesian Cross model is the same as the IS curve model.
The IS Curve: effect of fiscal policy
rC
IT
C
CGIC
CY
y
r
y
yoo
y
11
)(1
1
K.C. Spending multiplier
K.C. Tax-cut multiplier
IS Interest rate effect
Y2Y1
r
Y
r1
IS1IS2
Y
Any decrease in taxes (T) causes the IS curve to shift right by an amount magnified by the Keynesian Cross tax-cut multiplier
The IS Curve: shifts
• To sum up the previous two slides:• The IS curve shifts right if there is:
– an increase in Co + Io + G, or
– a decrease in T.
Y2Y1
Y2Y1
Deriving the IS curve: graphs
r I
Y
PE
r
Y
PE =C +I (r1 )+G
PE =C +I (r2 )+G
r1
r2
PE =Y
IS
I PE
Y
Any change in the real interest rate will cause an opposite change in real total GDP by a multiple determined by the size of the interest rate effect.
Y1
Y1
The natural rate of interest
Y
PE
r
Y
PE = C + I(r1) + G
r1
PE = Y
IS
The natural rate of interest will re-appear in chapter 14. But there it will be denoted ρ. (Confused???)
Why the IS curve is negatively sloped
• A fall in the interest rate motivates firms to increase investment spending, which drives up total planned spending (PE ).
• To restore equilibrium in the goods market, output (a.k.a. actual expenditure, Y ) must increase.
Fiscal Policy and the IS curve
• We can use the IS-LM model to see how fiscal policy (G and T ) affects aggregate demand and output.
• Let’s start by using the Keynesian cross to see how fiscal policy shifts the IS curve…
Y2Y1
Y2Y1
Shifting the IS curve: G
At any value of r, G PE Y
Y
PE
r
Y
PE =C +I (r1 )+G1
PE =C +I (r1 )+G2
r1
PE =Y
IS1
The horizontal distance of the IS shift equals
IS2
…so the IS curve shifts to the right.
1
1 MPC
Y G Y
NOW YOU TRY:
Shifting the IS curve: T
• Use the diagram of the Keynesian cross or loanable funds model to show how an increase in taxes shifts the IS curve.
THE MONEY MARKET IN THE SHORT RUN: THE LM CURVE
The theory of short-run equilibrium in the money market
The Theory of Liquidity Preference
• The theory of short-run equilibrium in the money market is exactly the same as the theory of long-run equilibrium in the money market that we saw in Chapter 5– Please review Chapter 5
Review of Ch. 5
Money demand and the interest rate
• Liquid assets are assumed to earn no interest• Illiquid assets are assumed to earn the
nominal interest rate i • Therefore, an increase in i is assumed to
reduce the demand for money• That is, money demand (Md) is assumed to be
inversely related to the nominal interest rate (i)
Review of Ch. 5
Money demand and the price level
• We also hold some of our wealth in the form of money—in liquid form—because money is an excellent medium of exchange
Review of Ch. 5
Money demand and the price level
• Recall that nominal GDP is the market value of all final goods and services
• It is also the total expenditure on all final goods and services
• Therefore, the bigger our nominal GDP, the bigger will be our need for money, as money is a medium of exchange
• It is, therefore, assumed that money demand is directly related to nominal GDP
Review of Ch. 5
Money demand and the price level
• Let P represent the overall level of prices, as measured by the GDP Deflator
• Recall from chapter 2 that the GDP Deflator = Nominal GDP / Real GDP
• Therefore, Nominal GDP = GDP Deflator ✕ Real GDP = P ✕ Y
• It is, therefore, assumed that money demand (Md) is directly related to nominal GDP (PY)
Review of Ch. 5
Money Demand
• So, Md is– inversely related to i, and– directly related to PY
• Md = L(i)PY– L(i) is the liquidity function– It is inversely related to i, the nominal interest rate
Review of Ch. 5
Money Demand: example
• Md = L(i)PY– L(i) is the liquidity function– It is inversely related to i, the nominal interest rate
• Specific form of L(i):– L(i) = Lo/i
– Lo represents all factors other than P, Y and i that also affect money demand
Review of Ch. 5
Money Demand = Money Supply
• M denotes money supply• Md = L(i)PY denotes money demand• Therefore, M = L(i)PY denotes equilibrium in
the money market
Review of Ch. 5
Money Demand = Money Supply
At this point, you should be able to do problem 5 on page 326 of the textbook. Please try it.
The LM Equation
Money Demand = Money Supply
Prices are sticky in the short run
• Recall that the long-run analysis of Chapter 5 assumed that P is endogenous. – Recall also that in the long run P changes
proportionately with M.
• The short-run analysis in the IS-LM model assumes that P is exogenous: it is what it is, it is historically determined– That is, the overall price level is “sticky”: what it
was last week, it will be this week too
Prices are sticky in the short run
• This sticky-prices assumption is the crucial distinction between long-run and short-run macroeconomic analysis
• Except this assumption, all assumptions made in short-run analysis are also assumed in long-run analysis
• So, the differences between long-run and short-run theories are caused by this sticky-prices assumption
Money Demand = Money Supply
The LM Curve: algebra to graph
• The LM curve shows all combinations of r and Y for which the money market is in equilibrium
• Note that the LM curve is upward rising
r
YY1
r1
r2
Y2
LM
The LM Curve: algebra to graph
• The LM curve shifts (down) right if:– M/P or Eπ increases– Lo decreases
• Moreover, if Eπ increases (decreases), the LM curve shifts down (up) by the exact same amount!
r
Y
r2
Y0
LM1 LM2
r1
NOW YOU TRY:
Shifting the LM curve
• Suppose a wave of credit card fraud causes consumers to use cash more frequently in transactions.
• Use the liquidity preference model to show how these events shift the LM curve.
SHORT-RUN EQUILIBRIUM IN THE IS-LM MODEL
Both the goods market and the money market need to be in equilibrium
Short-run equilibrium
The short-run equilibrium is the combination of r and Y that simultaneously satisfies the equilibrium conditions in both the goods and money markets:
( ) ( )Y C Y T I r G
Y
r
IS
LM
Equilibriuminterestrate
Equilibriumlevel ofincome
YPErLM )(
Short-run equilibrium
By insisting that both the goods market and the money market need to be in equilibrium, we have managed to find a way to pinpoint both r and Y simultaneously!
( ) ( )Y C Y T I r G Y
r
IS
LM
Equilibriuminterestrate
Equilibriumlevel ofincome
YPErLM )(
Short-run equilibrium
Y
r
IS
LM
Equilibriuminterestrate
Equilibriumlevel ofincome
But, the Keynesian Cross model could determine only equilibrium GDP. The IS-LM model determines the equilibrium interest rate as well.
The IS-LM Model: summary• Short-run equilibrium in the goods market is represented
by a downward-sloping IS curve linking Y and r.• Short-run equilibrium in the money market is represented
by an upward-sloping LM curve linking Y and r.• The intersection of the IS and LM curves determine the
short-run equilibrium values of Y and r.• The IS curve shifts right if there is:
– an increase in Co + Io + G, or– a decrease in T.
• The LM curve shifts right if:– M/P or Eπ increases, or– Lo decreases
Y
r
IS
LM
The Big Picture
KeynesianCrossKeynesianCross
Theory of Liquidity Preference
Theory of Liquidity Preference
IScurve
IScurve
LM curveLM
curve
IS-LMmodelIS-LMmodel
Agg. demand
curve
Agg. demand
curve
Agg. supplycurve
Agg. supplycurve
Model of Agg.
Demand and Agg. Supply
Model of Agg.
Demand and Agg. Supply
Explanation of short-run fluctuations
Explanation of short-run fluctuations
Preview of Chapter 12
In Chapter 12, we will– use the IS-LM model to analyze the impact of
policies and shocks.– learn how the aggregate demand curve comes
from IS-LM.– use the IS-LM and AD-AS models together to
analyze the short-run and long-run effects of shocks.
– use our models to learn about the Great Depression.