eco3203 chap 12 & 13

the keynesian cross

• simple closed-economy model in which income is determined by expenditure

• notation:

  • I = planned investment

  • PE = C + I + G = planned expenditure

  • Y = real GDP = actual expenditure

• actual - planned expenditure = unplanned inventory investment

IS curve

• relationship between income and the interest rate

• shows combinations of interest rates and output where the goods market is in equilibrium

• Y = C(Y - T bar) + I(r) + G bar

• shift:

  • ΔY = (-mpc / 1 - mpc) * ΔT

    • ΔT works better in calculations

variable y

• Y = C + I + G (equilibrium condition)

• ΔG = ΔY * (1 - mpc)

• solving for Δy:

  • ΔY = (1/1 - mpc) * ΔG

• ΔY / ΔG = 1 / 1 - mpc

money market model and money demand

• money demand equation: (M / P)^d = L(r)

LM curve

• shows the changes in the money market’s equilibrium

IS-LM graph

IS shocks

• exogenous changes in demand

crowding out

• increase in government spending leads to less investment in the private sector

2001 recession

• 2.1 million jobs lost

• unemployment rate rose from 3.9% to 5.8%

• GDP growth slowed to 0.8%

federal funds rate

• the interest rate banks charge one another

• the Fed targets this particular interest rate

AD curve

AD-AS model

great depression

• stock market crash (1929, 1933)

• investment decreased

  • due to: overbuilding in ‘20s; government spending increased while output/income decreased; widespread bank failures

• another depression unlikely

effects of borrowing on inflation

• if inflation goes down, the real cost of borrowing increases (and vice versa)

2008/2009 financial crisis

• bursting house price bubble

• foreclosure rates increased

• mortgage crisis

• declining consumer confidence, less investment and spending on consumer durables

• falling stock prices

• failing financial institutions

• 2009: real GDP falls, unemployment rate ~10%