Presentation is loading. Please wait.

Presentation is loading. Please wait.

goods market The market in which goods and services are exchanged and in which the equilibrium level of aggregate output is determined. money market The.

Similar presentations


Presentation on theme: "goods market The market in which goods and services are exchanged and in which the equilibrium level of aggregate output is determined. money market The."— Presentation transcript:

1

2 goods market The market in which goods and services are exchanged and in which the equilibrium level of aggregate output is determined. money market The market in which financial instruments are exchanged and in which the equilibrium level of the interest rate is determined.

3 The links between goods and money markets: The money market determines the interest rate. The demand for money in the money market is affected by income (which is determined in the goods market). The goods market determines income, which depends on planned investment. Planned investment in turn depends on the interest rate (which is determined in the money market). The key link between the two markets is the interest rate…

4 Planned investment spending is a negative function of the interest rate. An increase in the interest rate from 3 percent to 6 percent reduces planned investment from I 0 to I 1.

5

6

7 An increase in the interest rate from 3 % to 6 % lowers planned aggregate expenditure and thus reduces equilibrium income from Y 0 to Y 1

8

9 An increase in the interest rate (r) decreases output (Y) in the goods market because an increase in interest rate lowers planned investment. When income (Y) increases, this shifts the money demand curve to the right, which increases the interest rate (r) with a fixed money supply.

10 Planned investment depends on the interest rate, and money demand depends on aggregate output.

11 Each point on the IS curve corresponds to the equilibrium point in the goods market for the given interest rate. When government spending (G) increases, the IS curve shifts to the right, from IS 0 to IS 1. IS curve A curve illustrating the negative relationship between the equilibrium value of aggregate output (income) (Y) and the interest rate in the goods market.

12 Each point on the LM curve corresponds to the equilibrium point in the money market for the given value of aggregate output (income). Money supply (M s ) increases shift the LM curve to the right, from LM 0 to LM 1. LM curve A curve illustrating the positive relationship between the equilibrium value of the interest rate and aggregate output (income) (Y) in the money market.

13 Equilibrium in the goods market (IS). Equilibrium in financial markets (LM). When the IS curve intersects the LM curve, both goods and financial markets are in equilibrium.

14 The IS-LM diagram is a useful way of seeing the effects of changes in monetary and fiscal policies on equilibrium aggregate output (income) and the interest rate through shifts in the two curves. Always keep in mind the economic theory that lies behind the two curves. Do not memorize what curve shifts when; be able to understand and explain why the curves shift. This means going back to the behavior of households and firms in the goods and money markets.

15 When G increases, the IS curve shifts to the right. This increases the equilibrium value of both Y and r.

16 When M s increases, the LM curve shifts to the right. This increases the equilibrium value of Y and decreases the equilibrium value of r.

17 Expansionary Policy Effects: expansionary fiscal policy - An increase in government spending or a reduction in net taxes aimed at increasing aggregate output (income) (Y). expansionary monetary policy - An increase in the money supply aimed at increasing aggregate output (income) (Y). Contractionary Policy Effects: contractionary fiscal policy - A decrease in government spending or an increase in net taxes aimed at decreasing aggregate output (income) (Y). contractionary monetary policy - A decrease in the money supply aimed at decreasing aggregate output (income) (Y).

18 An increase in government spending G from G 0 to G 1 shifts the planned aggregate expenditure schedule from 1 to 2. The crowding-out effect of the decrease in planned investment (brought about by the increased interest rate) then shifts the planned aggregate expenditure schedule from 2 to 3. crowding-out effect The tendency for increases in government spending to cause reductions in private investment spending.

19 Effects of an expansionary fiscal policy:

20 Effects of an expansionary monetary policy:

21 Effects of a contractionary fiscal policy: Effects of a contractionary monetary policy:

22 policy mix The combination of monetary and fiscal policies in use at a given time.

23 The Impact of an Increase in the Price Level on the Economy Assuming No Changes in G, T, and M s

24 aggregate demand (AD) curve A curve that shows the negative relationship between aggregate output (income) and the price level. Each point on the AD curve is a point at which both the goods market and the money market are in equilibrium.

25 At all points along the AD curve, both the goods market and the money market are in equilibrium. The policy variables G, T, and M s are fixed.

26 It is important that you realize what the aggregate demand curve represents. The aggregate demand curve is more complex than a simple individual or market demand curve. The AD curve is not a market demand curve, and it is not the sum of all market demand curves in the economy. To understand what the aggregate demand curve represents, you must understand the interaction between the goods market and the money markets.

27 The Consumption Link The consumption link provides another reason for the AD curves downward slope. An increase in the price level increases the demand for money, which leads to an increase in the interest rate, which leads to a decrease in consumption (as well as planned investment), which leads to a decrease in aggregate output (income). The initial decrease in consumption (brought about by the increase in the interest rate) contributes to the overall decrease in output.

28 The Real Wealth Effect real wealth, or real balance, effect The change in consumption brought about by a change in real wealth that results from a change in the price level.

29 An increase in the money supply (M s ) causes the aggregate demand curve to shift to the right, from AD 0 to AD 1. This shift occurs because the increase in M s lowers the interest rate, which increases planned investment (and thus planned aggregate expenditure). The final result is an increase in output at each possible price level.

30 An increase in government purchases (G) or a decrease in net taxes (T) causes the aggregate demand curve to shift to the right, from AD 0 to AD 1. The increase in G increases planned aggregate expenditure, which leads to an increase in output at each possible price level. A decrease in T causes consumption to rise. The higher consumption then increases planned aggregate expenditure, which leads to an increase in output at each possible price level. The Effect of an Increase in Government Purchases or a Decrease in Net Taxes on the AD Curve

31 Factors That Shift the Aggregate Demand Curve:

32


Download ppt "goods market The market in which goods and services are exchanged and in which the equilibrium level of aggregate output is determined. money market The."

Similar presentations


Ads by Google