ECMB06 Chapter 10

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Economics for Management Studies
Jack Parkinson

Part IV Business Cycle Theory The Economy in the Short Run Chapter 10Aggregate Demand I Building the ISLM Model ISLM model is the leading interpretation of Keyness theoryThe goal of the model is to show what determines national income for any given price levelISLM model can show what causes income to change in the short run when the price level is fixed Or it can show what causes aggregate demand curve to shift AD AD23AD 1Price Level P For a given price level national incomefluctuates because of shifts in the aggregatedemand curve Fixed Price Level SRAS Income Output YIS curve stands for investment and saving and it represents whats going on in the market for goods and servicesLM stands for liquidity and money and the curve represents whats happening to the supply and demand for money Because the interest rate influences both investment and money demand it is the variable that links the two halves of the ISLM model 101 The Goods Market and the IS CurveThe IS curve plots the relationship between the interest rate and the level of income that arises in the market for goods and servicesThe Keynesian CrossIn the book The General Theory Keynes it proposed that an economys total income was in the short run determined largely by the desire to spend by households firms and the government When these consumers spend more goods and services are being produced and sold Thus more workers to hireKeynes proposed that inadequate spending causes recession and depression Planned ExpenditureActual ExpenditureThe amount households firms and the government spend on goods and services It equals the economys GDPPlanned Expenditure PEThe amount households firms and the government would like to spend on goods and services Why would actual differ from planned Because firms might engage in unplanned inventory investment because their sales do not meet their expectationsWhen firms sell less of their product than they planned their stock of inventories automatically rises and viceversa
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