Tài liệu The IS-LM model doc

Simidian CHAPTER ELEVEN Aggregate Demand II Now that we’ve assembled the IS-LM model of aggregate demand, let’s apply it to three issues: 1 Causes of fluctuations in national income 2 Ho

Chapter Eleven 1

A PowerPoint  Tutorial

to Accompany macroeconomics, 5th ed.

N Gregory Mankiw

Mannig J Simidian

CHAPTER ELEVEN

Aggregate Demand II

Now that we’ve assembled the IS-LM model of aggregate demand,

let’s apply it to three issues:

1) Causes of fluctuations in national income

2) How IS-LM fits into the model of aggregate supply and aggregate

demand

3) The Great Depression

Chapter Eleven 3

IS -L

M

The intersection of the IS curve and the LM curve determines the level of national income

When one of these curves shifts, the short-run equilibrium of the economy changes, and national income fluctuates Let’s examine how changes in policy and shocks to the economy can

cause these curves to shift

Chapter Eleven 5

LM r

Y

IS

A

+∆G Consider an increase in government purchases

This will raise the level of income by ∆G/(1- MPC)

IS´

B

The IS curve shifts to the right by ∆G/(1- MPC) which raises income

and the interest rate

Chapter Eleven 7

IS r

Y

LM

B

+∆M Consider an increase in the money supply

The LM curve shifts downward and lowers the interest rate which raises

income Why? Because when the Fed increases the supply of money, people

have more money than they want to hold at the prevailing interest rate As a

result, they start depositing this extra money in banks or use it to buy bonds

The interest rate r then falls until people are willing to hold all the extra

money that the Fed has created; this brings the money market to a new

equilibrium The lower interest rate, in turn has ramifications for the goods

market A lower interest rate stimulates planned investment, which increases

planned expenditure, production, and income Y

The IS-LM model shows that monetary policy influences income by

changing the interest rate This conclusion sheds light on our analysis

of monetary policy in Chapter 9 In that chapter we showed that in

the short run, when prices are sticky, an expansion in the money

supply raises income But, we didn’t discuss how a monetary

expansion induces greater spending on goods and services a process

called the monetary transmission mechanism.

The IS-LM model shows that an increase in the money supply lowers

the interest rate, which stimulates investment and thereby expands the

demand for goods and services

Chapter Eleven 9

You probably noticed from the IS and LM diagrams that r and Y were on

the two axes Now we’re going to bring a third variable, the price level

(P) into the analysis We can accomplish this by linking both

two-dimensional graphs

r

Y

IS

LM(P1) A

A

AD

To derive AD, start at point A in the top graph Now increase the price level from P1

to P2

An increase in P lowers the value of real money balances, and Y, shifting LM leftward to point B

The +∆P triggers a sequence of events that end with a -∆Y, the inverse relationship that defines the downward slope of AD

Notice that r increased Since r increased, we know that investment will decrease as it just got more costly to take on various investment projects This sets off a multiplier process since -∆I causes a –∆Y

The -∆Y triggers -∆C as we move up the IS curve

LM(P2)

B

B

P2

P1

Chapter Eleven 11

+∆G

This translates into a rightward shift of the IS and AD curves.

LM (P2)

Suppose there is a +∆G

In the short-run, we move along SRAS from

point A to point B

But as the output market clears, in the long-run,

the price level will increase from P0to P2

This +∆P decreases the value of real money

balances, which translates into a leftward shift

of the LM curve

Finally, this leaves us at point C in both diagrams

r

Y

IS

LM(P0)

AD

P0

AD´

IS´

SRAS A

A

B

B

C

LRAS

Y = C (Y-T) + I(r) + G

M/ P = L (r, Y)

Now it’s time to determine the effects on the variables in the economy.

For the variables Y, P, and r, you can read the effects right off the diagrams.

Remember that SR is the movement from A to B.

+, because Y moved from Y* to Y´

0, because prices are sticky in the SR

+, because a +∆Y leads to a rise in r

as IS slides along the LM curve.

+, because a +∆Y increases the level of

consumption (↑C=C(↑Y-T)).

– , since r increased, the level of

Y

P

r

C

I

r

IS´

C

LRAS

LM(P2)

Chapter Eleven 13

+, in order to eliminate the excess demand at P0

0, because rising P shifts LM to left, returning

Y to Y* as required by long-run LRAS.

+, reflecting the leftward shift in LM due

to +∆P

0, since both Y and T are back to their initial

levels (C=C(Y-T))

– – , since r has risen even more due to the

+∆P.

Y

P

r

C

I

For the variables Y, P and r, you can read the effects right off the diagrams.

Remember that LR is the movement from A to C.

r

Y

AD

P0

AD´

IS´

SRAS A

A

B

B

C

LRAS

*

Y Y´

LM(P2)

LM′

B

AD´

B

Notice that M\was increased, thus increasing the value of the real money

supply which translates into a rightward shift of the LM and AD curves

Suppose there is a +∆M

Look at the appropriate equation

that captures the M term:

In the short-run, we move along SRAS from

point A to point B

But as the output market clears, in the long-run,

the price level will increase from P0to P2

This +∆P decreases the value of the

real money supply which translates into a

leftward shift of the LM curve

Finally, this leaves us at point C in both diagrams

C

AD

IS r

Y

LM(P0)

A

A

LRAS

= C

P2 M/ P = L (r, Y)

M/ P = L (r, Y)

Chapter Eleven 15

Now it’s time to determine the effects on the variables in the economy.

For the variables Y, P, and r, you can read the effects right off the diagrams.

Remember that SR is the movement from A to B.

+, because Y moved from Y* to Y´

0, because prices are sticky in the SR

–, because a +∆Y leads to a decrease in r

as LM slides along the IS curve.

+, because a +∆Y increases the level of

consumption (↑C=C(↑Y-T)).

+ , since r increased, the level of

investment decreased.

Y

P

r

C

I

LM′

B

AD´

B C

AD

IS r

Y

LM(P0)

A

A

LRAS

= C

P2

(P2)

Y´

Y*

+, in order to eliminate the excess demand at P0

0, because rising P shifts LM to left, returning

Y to Y* as required by LRAS.

0, reflecting the leftward shift in LM due

to +∆P, restoring r to its original level.

0, since both Y and T are back to their initial

levels (C=C(Y-T)).

0, since Y or r has not changed.

Y

P

r

C

I

For the variables Y, P and r, you can read the effects right off the diagrams.

Remember that LR is the movement from A to C.

LM′

B

C

= C

P

IS r

LM(P0) A

LRAS

Chapter Eleven 17

LM(P0)

1) +∆Ccauses the IS curve to shift right to IS‘

LRAS

2) This leads to a rightward shift in AD

to AD’ Short Run:

Move from A to B

Long Run:

Market clears at P0to P2 from B to C

3) +∆P causes LM(P0) to shift leftward

to LM(P2) due to the lowering of the real value of the money supply

r

Y P

Y

IS

AD

IS'

P0

AD' LRAS

LM(P2)

Α•

•

Α

•

Β

•

Β

P2

•

•

C

C

Y = C (Y-T) + I(r) + G

IS -L M

M/ P = L (r, Y)

Chapter Eleven 19

Short Run:

-Long Run:

0 + ++

+

SRAS

r

Y P

Y

IS

AD

IS'

P0

AD' LRAS

LM(P2)

Α •

• Α

• Β

• Β

• C

C

LM(P0)

The spending hypothesis suggests that perhaps the cause of the

decline may have been a contractionary shift of the IS curve

The money hypothesis attempts to explain the effects of the historical

fall of the money supply of 25% from 1929 to 1933 during which

time unemployment rose from 3.2% to 25.2.%

Some economists say that deflation worsened the Great Depression

They argue that the deflation may have turned what in 1931 was a

typical economic downturn into an unprecedented period of high

Chapter Eleven 21

LM

Y

IS

A IS´

B

An expected deflation (a negative value of πe) raises the real interest

rate for any given nominal interest rate, and this depresses investment

spending The reduction in investment shifts the IS curve downward

The level of income and the nominal interest rate (i) fall, but the real

interest rate (r) rises

i2

r1= i1

r2 interest rate, i

Monetary transmission mechanism Pigou Effect

Debt-deflation theory