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ECON 305

Econ 10 10/19/13  IS-LM model: model ofAD that shows what determines aggregate income for a given price level by analyzing the interaction between the goods market and the money market.  National income for a given price level  What causes income to change when prices are fixed OR  What causes theAD curve to shift  IS curve: investment and saving  and represents what’s going on in the market for goods and services (interest rate and income)  LM curve: liquidity and money  and represents what’s happening to the supply and demand for money  Interest rate influence investment and money demand (LINKS)  Keynesian cross: simple model of income determination, based in the ideas in Keynes’s General theory which shows how changes in spending can have a multiplied effect on aggregate income.  Income determined by spending plans: spend more, produce more, hire more  Planned expenditure  Actual: amount households, firms, and government spend on goods and services: gdp  Planned: how much they would like to spend • Differ because the amount sold influences their inventories, which then influence investment • PE=C(Y −T)+I+G ́ ́ ♦ Slopes upward because higher income means higher consumption and therefore higher PE. ♦ MPC  Economy in equilibrium  Actual expenditure = planned expenditure  Y = PE  Fiscal policy and the multiplier effect: government purchases  Higher government purchases result in higher planned expenditure for any level of income.  Government-purchases multiplier: change in aggregate income resulting from a one-dollar change in government purchases. • Change in Y / change in G • This is because an increase in income also increases consumption ♦ So an increase in government purchases increases two other things 1 • = (1−MPC)  Fiscal policy and the multiplier: Taxes  Increase in t raises disposable income (Y-T) and increases consumption by MPC x T  Tax multiplier: the amount income changes in response to a $1 change in taxes • ∆Y = −MPC ∆T 1−MPC • The negative is j
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