- No prices or interest rates
- Consumption function based on income
- Multiplier/Magnified
-Investment is the problem: based on expectations of future changes and the volatility of this causes business cycles
- Changes in exports/imports have a multiplicative impact on the economy
Ch. 6
- Money Demand is a function of income (transactions demand for money)
- Interest rate demand for money (speculative demand)
- Classical theory money demand was only a function of interest rates
- Money supply is controlled by the monetary authority/central bank/Federal Reserve
- Increase is Ms, equilibrium will move outward and reduces interest rates
- Investment function has an inverse relationship to interest rates (profitable opportunities)
- Interest sensitivity of investment demand was small
- Do not have to memorize LM/IS equations
- LM curve is derived from the equilibrium of
- The intercept of the curve has money supply in it, so changes of the money supply change the LM curve (increase is Ms decrease LM intercept, decrease in Ms increase LM intercept)
- Interest sensitivity of money demand is high, LM curve is flat and when it's low the LM curve is steep
- IS curve = equilibrium between interest rates and income and is negatively sloped (interest rates rising, investment goes down)
- Intercept of IS has autonomous factors (A, I, G, T) shift the IS curve
- Increasing taxes reduces the IS Curve intercept
- Interest sensitivity of investment is low, IS is steep, if it's high, the IS curve is flat
- Keynes: Interest sensitivity of money demand is high (flat LM curve), and investment is low (steep IS curve)
- Classical: Interest sensitivity of money demand is low (steep LM curve), and investment is high (flat IS curve)
- **Remember Keynes introduced interest sensitivity of money demand so he thought it was high (flat LM), the rest can be worked out logically**
Ch. 7
- How steep are the IS and LM curves and what shifts them?
- IS curve does not shift is Ms is changed
- Decrease in Ms increases the intercept of LM, shifting it back and to the left
- Increasing money supply reduces interest rates and investment increases, causing an expansionary
- Fiscal policy shift the IS curve, doesn't effect the LM
- Increasing the intercept of the IS curve (gov't spending) pushing interest rates up and increases GDP, income
- Reduction of gov't spending shifts the IS Curve to the left and decreases income and GDP
- Keynes favorite fiscal policy because he though the LM curve was flat, and IS was steep
- Monetary policy more effective in non-keynesian world, steep LM, flat IS
Ch. 8
- Introduce prices into the money demand function, the Fed doesn't control the real money supply, only the nominal money supply (Ms).
- Real money supply is Ms/P (prices increases, real Ms falls)
- Prices in the LM curve: intercept changes as prices change
- Prices go up, LM curve up (GDP declines). Prices fall, LM curve shifts down (GDP increases)
- Prices and GDP are inversely related
- Aggregate prices on Y, GDP on X axis, aggregate demand is negatively sloped
- Perfect adjustment by labor supply when prices change. Increase 20% in prices, labor supply increases 20% (money wages increase 20%) (moving in lock step in perfectly adjusting labor market: classical theory)
- Keynes: contractional position on wage determination: people are reasonable, but will focus on relative wages.
- Relative wages cause wages in the downward direction to be sticky (inflexible decreasing wages, they may fall with prices, but not as far)
- Keynes wage rigidity: aggregate supply curve is very close to horizontal
- Keynes accepted the flexible price, variable wage theory (wages will fall with prices but not as much). Positive aggregate supply curve in price/? plane
Current Events:
- Unemployment: 6.1%
- CPI: -0.1%
- Labor force falling as unemployment stayed the same and more people are jobless
- 700 billion dollar bail out
- Banks aren't lending currently: both flat and steep LM curve (vertical when enacting expansionary fiscal policy) (horizontal when enacting expansionary monetary policy)
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