Intermediate Macroeconomics
Lecture 7
How the SR and LR Differ
? In the LR,prices are flexible and can
respond to changes in S or D,In the SR,
many prices are stuck at some
predetermined level,
? In the SR,monetary policy does have a
potent effect on output and employment!
Aggregate Demand
? Shifts in the AD curve --- change in money supply
M V PY? 1M Y k YPV??
P
Y
AD
1
100 170
2
50 85
AD’ (M ) ?
Aggregate Supply
? LR v.s,SR
P
Y
P
Y
LRAS SRAS
Shocks to AD
? Introduction of ATM
P
Y
LRAS
SRAS
Y?
A
B
C
M V PY?
Shocks to AS
? Only on SRAS (change the cost of production)
? How to deal with adverse supply shock
P
Y
LRAS
SRAS
AD
Y?
A
SRAS’ B C
Shocks to AS
? When the economy suffers from adverse
supply shock,policy makers have 2
choices
1,Do nothing
? stagflation ? back to normal
2,Increase AD to accommodate the shock
? inflation
Shocks to AS
? Change in oil price
y e a r c h a n g e i n p ( % ) C P I ( % ) U n e m pl oy m e n t r a t e
78 9.4 7.7 6.1
79 25.4 11.3 5.8
80 47.8 13.5 7.0
81 44.4 10.3 7.5
82 -8.7 6.1 9.5
83 -7.1 3.2 9.5
84 -1.7 4.3 7.4
85 -7.5 3.6 7.1
86 -44.5 1.9 6.9
87 18.3 3.6 6.1
Shocks to AS
? Energy use (kg of oil equivalent per capita)
c o u n t r y 99 00 01
China 891.97 904.8 895.84
United States 8066.01 8163.06 7996.04
y e a r c h a n g e i n p ( % ) C P I ( % ) U n e m pl oy m e n t r a t e
1994 - 6, 4 5 2, 6 4.9
1995 6, 9 6 2, 8 4.8
1996 2 2, 1 5 2, 9 4.6
1997 - 7, 2 8 2, 3 4.2
1998 - 3 7, 2 2 1, 6 4.2
1999 3 8, 9 6 2, 2 3.4
2000 6 5, 5 6 3, 4 3.4
2001 - 1 6, 0 6 2, 8 4.7
2002 - 0, 8 3 1, 6 5.5
2003 2 1, 3 9 2, 2 5.6
The IS-LM Model
? Classical model cannot explain the Great
Depression
? LR v.s,SR
? IS ---,investment” and,savings”
? LM ---,liquidity” and,money”
? Takes the price level as exogenous and
shows what determines national income
The IS-LM Model
1,The goods market and the IS curve
① The Keynesian Cross
Planned expenditure,
GICE ???
)( TYCC ??
?? II
?? TT
??? ???? GITYCE )(
?? GG
The IS-LM Model
E
Y
YE ?
??? ???? GITYCE )(
45
?Y
?E
Unplanned inventory
accumulation
Unplanned drop
in inventory
The IS-LM Model
② How does the economy get to the equilibrium?
e.g,Y is higher than equilibrium level
? Y bigger than planned E
? more inventories
? lay off workers & reduce production
? Y gets smaller
The IS-LM Model
③ Government-purchase multiplier
$100 Increase in G
? Directly increases E by $100
? Y increases by $100
? C increases by $100*MPC
? Y increases by $100*MPC
? C increases by $100*MPC*MPC
? Y increases by $100*MPC*MPC
……
GM P CM P CM P CY ????????,,, )1( 32
The IS-LM Model
? Government-purchases multiplier
E
Y
?Y
?E
G?
Y’
M P CG
Y
???
?
1
1
1
GYG
M PC
?? ? ? ?
?
The IS-LM Model
? Tax multiplier
$100 decrease in T
? Directly increases E by $100*MPC
? Y increases by $100*MPC
? C increases by $100*MPC*MPC
? Y increases by $100*MPC*MPC
……
TM P CM P CM P CY ???????,,, )( 32
The IS-LM Model
? Tax multiplier
E
Y
?Y
?E
MPCT ??
Y’
M P C
M P C
T
Y
???
?
1 1
M PCYT
M PC? ? ??
The IS-LM Model
2,r,I and the IS curve
r
I
r
Y
E
Y
r1
r2
I(r1) I(r2)
E -- I(r1)
E -- I(r2)
Y1
A
Y2
B
IS
The IS-LM Model
? Increase in G
r
Y
E
Y
E – G2
E – G1
Y1 Y2
MPC
G
?
?
1
The IS-LM Model
3,A loanable-funds interpretation of the IS
curve
r
I
r
Y
r1
r2
S(Y2) S(Y1)
Y1
A
Y2
B
?? ???? GTYCYS )(
IS