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University of Toronto Scarborough
Economics for Management Studies
Jack Parkinson

Chapter 11: Aggregate Demand II: Applying the IS-LM Model Notes 11.1 Explaining Fluctuations with the IS-LM Model N the intersection of the IS curve and the LM cure determines the level of national income N when one of these curves shifts, the SR equilibrium of the economy changes, and national income fluctuates How Monetary Policy Shifts the LM Curve and Changes the Short-Run Equilibrium N monetary transmission mechanism the process by which changes in the money supply influence the amount that households and firms wish to spend on goods and services N the IS-LM model shows an important part of that mechanism: an increase in the money supply lowers the interest rate, which stimulates investment and thereby expands the demand for goods and services Shocks in the IS-LM Model N shocks to the IS curve are exogenous changes in the demand for goods and services N some economists, including Keynes, have emphasized that such changes in demand can arise from investors animal spirits exogenous and perhaps self-fulfilling waves of optimism and pessimism N shocks to the IS curve may also arise from changes in the demand for consumer goods N shocks to the LM curve arise from exogenous changes in the demand for money 11.2 IS-LM as a Theory of Aggregate Demand From the IS-LM Model to the Aggregate Demand Curve N a change in income in the IS-LM model resulting from a change in the price level represents a movement along the AD curve N a change in income in the IS-LM model for a fixed price level represents a shift in the position of the AD curve 11.3 The Great Depression The Money Hypothesis Again: The Effects of Falling Prices N Pigou effect increase in C that results when a fall in price level raises real money balances and, thereby, consumers wealth N debt-deflation theory a theory according to which an unexpected fall in the price level redistributes real wealth from debtors to creditors and, therefore, reduces total spending in the economy Summary 1. The IS-LM model is a gene
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