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CHAPTER 9

CHAPTER 9. Aggregate Demand and Aggregate Supply. General Equilibrium. Labor market equilibrium = FE line. (Chapter 3) Goods market equilibrium = IS curve. (Chapter 4) Asset market equilibrium = LM curve. (Chapter 7). FE Line. Labor Market Equilibrium

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CHAPTER 9

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  1. CHAPTER 9 Aggregate Demand and Aggregate Supply

  2. General Equilibrium • Labor market equilibrium = FE line. (Chapter 3) • Goods market equilibrium = IS curve. (Chapter 4) • Asset market equilibrium = LM curve. (Chapter 7)

  3. FE Line Labor Market Equilibrium Equilibrium in the labor market leads to employment at its full-employment level and output at Ybar. FE is a vertical line at Ybar, since labor market equilibrium is unaffected by changes in the real interest rate.

  4. Changes in FE Line The full-employment line shifts right because of (1) a beneficial supply shock (higher Nbar, more productivity) (2) an increase in labor supply (same capital, more output) (3) an increase in the capital stock (same labor, more output) The full-employment line shifts left when the opposite happens to the three factors above (1) an adverse supply shock (lower Nbar, less productivity) (2) a decrease in labor supply (same capital, less output) (3) a decrease in the capital stock (same labor, less output)

  5. Goods Market Equilibrium In goods market, Id = Sd and each equilibrium gives r* and Y*.

  6. IS curve shifts to the right • The IS curve shifts to the right because of • an increase in expected future output • an increase in wealth • a temporary increase in government purchases • (4) a decline in taxes (if Ricardian equivalence doesn't hold) • (1) – (4) … due to Cd ↑, Sd↓, higher r* at goods market equilibrium. • an increase in the expected future marginal product of capital • a decrease in the effective tax rate on capital • (5) – (6) … due to Id ↑, higher r* at goods market equilibrium.

  7. IS curve shifts to the left • The IS curve shifts to the left when the opposite happens • (1) a decrease in expected future output • (2) a decrease in wealth • (3) a temporary decrease in government purchases • an increase in taxes (if Ricardian equivalence doesn't hold) • (1)– (4) … due to Cd↓, Sd↑, lower r* at goods market equilibrium. • (5) a decrease in the expected future marginal product of capital • an increase in the effective tax rate on capital • (5) – (6) … due to Id↓, lower r* at goods market equilibrium.

  8. Asset Market Equilibrium In asset market, Md = Ms and each equilibrium gives r* and Y*.

  9. LM curve shifts to the right • The LM curve shifts to the right because of • (1) an increase in the nominal money supply • a decrease in the price level • (1) – (2) … due to Ms↑, lower r* at asset market equilibrium. • (3) an increase in expected inflation • (4) a decrease in the nominal interest rate on money • (5) a decrease in wealth • (6) a decrease in the risk of alternative assets relative to the risk of holding money • (7) an increase in the liquidity of alternative assets • an increase in the efficiency of payment technologies • (3) – (8) … due to Md↓, lower r* at asset market equilibrium.

  10. LM curve shifts to the left • The LM curve shifts to the left because of • (1) a decrease in the nominal money supply • an increase in the price level • (1) – (2) … due to Ms↓, higher r* at asset market equilibrium. • (3) a decrease in expected inflation • (4) an increase in the nominal interest rate on money • (5) an increase in wealth • (6) an increase in the risk of alternative assets relative to the risk of holding money • (7) a decrease in the liquidity of alternative assets • a decrease in the efficiency of payment technologies • (3) – (8) … due to Md↑, higher r* at asset market equilibrium.

  11. End of Lecture 1 Week 7 • General Equilibrium • Labor Market Equilibrium = FE Line • Goods Market Equilibrium = IS Curve • Asset Market Equilibrium = LM Curve

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