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Aggregate Demand II: Applying The - Model: IS LM
Aggregate Demand II: Applying The - Model: IS LM
CHAPTER
N. GREGORY MANKIW
PowerPoint® Slides by Ron Cronovich
© 2007 Worth Publishers, all rights reserved
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.
r1
2. …causing the
interest rate to fall r2
3. …which increases IS
investment, causing Y
Y1 Y2
output & income to
rise.
If Congress raises G, r
the IS curve shifts right. LM1
If Congress raises G, r
the IS curve shifts right. LM1
LM2
To keep r constant,
r2
Fed increases M r1
to shift LM curve right.
IS2
Results: IS1
Y Y 3 Y1 Y
Y1 Y2 Y3
r 0
r3
To keep Y constant,
r2
Fed reduces M r1
to shift LM curve left.
IS2
Results: IS1
Y 0 Y
Y1 Y2
r r3 r1
Estimated Estimated
Assumption about value of value of
monetary policy Y / G Y / T
1500
Standard & Poor’s
Index (1942 = 100)
1200 500
900
600
300
1995 1996 1997 1998 1999 2000 2001 2002 2003
CHAPTER 11 Aggregate Demand II slide 19
CASE STUDY:
The U.S. recession of 2001
Causes: 2) 9/11
increased uncertainty
fall in consumer & business confidence
result: lower spending, IS curve shifted left
Causes: 3) Corporate accounting scandals
Enron, WorldCom, etc.
reduced stock prices, discouraged investment
01
02
03
00
01
01
02
02
02
03
00
00
01
/20
/ 20
/ 20
/20
/20
/2 0
/20
/20
/20
/2 0
/20
/20
/ 20
/20
/01
/02
/03
/05
/06
/08
/09
/09
/11
/ 06
/ 06
/ 09
/03
/03
04
04
01
04
01
01
01
07
10
07
10
04
07
10
Y Y remain constant
AD1
AD2
Y Y
CHAPTER 11 Aggregate Demand II slide 30
The SR and LR effects of an IS shock
r LRAS LM(P )
1
In
In the
the new
new short-run
short-run
equilibrium, Y Y
equilibrium, IS1
IS2
Y Y
P LRAS
P1 SRAS1
AD1
AD2
Y Y
CHAPTER 11 Aggregate Demand II slide 31
The SR and LR effects of an IS shock
r LRAS LM(P )
1
In
In the
the new
new short-run
short-run
equilibrium, Y Y
equilibrium, IS1
IS2
Y Y
Over
Over time,
time, P
P gradually
gradually
falls,
falls, which
which causes
causes P LRAS
•• SRAS
SRAS toto move
move down.
down. P1 SRAS1
•• M/P
M/P to
to increase,
increase,
which
which causes
causes LM
LM AD1
to AD2
to move
move down.
down.
Y Y
CHAPTER 11 Aggregate Demand II slide 32
The SR and LR effects of an IS shock
r LRAS LM(P )
1
LM(P2)
IS1
IS2
Y Y
Over
Over time,
time, P
P gradually
gradually
falls,
falls, which
which causes
causes P LRAS
•• SRAS
SRAS toto move
move down.
down. P1 SRAS1
•• M/P
M/P to
to increase,
increase, P2 SRAS2
which
which causes
causes LM
LM AD1
to AD2
to move
move down.
down.
Y Y
CHAPTER 11 Aggregate Demand II slide 33
The SR and LR effects of an IS shock
r LRAS LM(P )
1
LM(P2)
This
This process
process continues
continues IS1
until
until economy
economy reaches
reaches aa IS2
long-run
long-run equilibrium
equilibrium with
with Y Y
Y Y P LRAS
P1 SRAS1
P2 SRAS2
AD1
AD2
Y Y
CHAPTER 11 Aggregate Demand II slide 34
EXERCISE:
Analyze SR & LR effects of M
a. Draw the IS-LM and AD-AS r LRAS LM(M /P )
1 1
diagrams as shown here.
b. Suppose Fed increases M.
Show the short-run effects
IS
on your graphs.
c. Show what happens in the Y
Y
transition from the short run
to the long run. P LRAS
180 15
160 10
1. IS-LM model
a theory of aggregate demand
exogenous: M, G, T,
P exogenous in short run, Y in long run
endogenous: r,
Y endogenous in short run, P in long run
IS curve: goods market equilibrium
LM curve: money market equilibrium
2. AD curve
shows relation between P and the IS-LM model’s
equilibrium Y.
negative slope because
P (M/P ) r I Y
expansionary fiscal policy shifts IS curve right,
raises income, and shifts AD curve right.
expansionary monetary policy shifts LM curve right,
raises income, and shifts AD curve right.
IS or LM shocks shift the AD curve.
CHAPTER 11 Aggregate Demand II slide 46