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Lecture 17

ECON 3430 Lecture 17: CH21 book powerpoint notes
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Department
Economics
Course Code
ECON 3430
Professor
Brenda Spotton- Visano

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The IS Curve Chapter 21 Planned Expenditure and Aggregate Demand Planned expenditure The total amount of spending on domestically produced goods and services that households, businesses, the government, and foreigners want to make Aggregate demand The total amount of output demanded in the economy Planned Expenditure and Aggregate Demand (cont’d) The total quantity demanded of an economy’s output is the sum of 4 types of spending: 1.1. Consumption expenditure (C) 1.2. Planned investment spending (I ) 1.3. Government purchases (G ) 1.4. Net exports (NX ) ad Y = C + I + G + NX The Components of Aggregate Demand The relationship between disposable income Y and cDnsumption expenditure C is called the consumption function a C = C + mpc x (Y – T) The term C is autonomous consumption expenditure Exogenous consumption unrelated to income The term mpc is the marginal propensity to consume Change in consumption expenditure that results from an additional dollar of disposable income Planned Investment Spending Fixed investment Planned spending on equipment, structures, and also s-pending on new residential housing Inventory investment Smaller than fixed investment, but can be unplanned Planned investment spending Interest rates Expectations The Investment Function Investments depend on the real interest rate since a new project must yield at least as high a return as the interest rate (cost of borrowing) Some investment is not sensitive to the interest rate, this is called autonomous investment a I = I + d x i The interest for investments r includes the short-term interest rates plus financial frictions f I = I + d x (r + f) Net Exports The exchange rate matter for trade, and is itself affected by interest rates An increase in interest rates appreciates the domestic currency, which lowers net exports As with investment, the net export function includes autonomous net exports and the part of net exports that is affected by changes in real interest rates NX = NX - xr Where x indicates how net exports responds to real interest rate Government Purchases and Taxes The government affects aggregate demand in two ways: through its purchases and taxes Government purchases: Government taxes: Goods Market Equilibrium Keynes recognized that equilibrium would occur in the economy when the total quantity of output produced in the economy equals the total amount of aggregate demand (planned expenditure) Solving for goods market equilibrium: Aggregate Output = Consumption Expenditure + Planned Investment Spending + Government Purchases + Net Exports Understanding the IS Curve What the IS curve tells us: traces out the points at which the goods market is in equilibrium Examines an equilibrium where aggregate output equals aggregate demand Assumes fixed price level where nominal and real quantities are the same IS curve is the relationship between equilibrium aggregate output and the interest rate The IS Curve Why the Economy Heads Toward the Equilibrium Interest rates and planned investment spending Negative relationship Interest rates and net exports Negative relationship IS curve The points at which th
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