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Chapter 8

Chapter 8. The Keynesian System AD and AS. AD Schedule. Keynesian model- output at equilibrium level. AD = total output. Previous Chapter- We know about the effects of (r) on I and Change in AD. Equilibrium- Output =AD and Md=Ms

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Chapter 8

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  1. Chapter 8 The Keynesian System AD and AS

  2. AD Schedule • Keynesian model- output at equilibrium level. AD = total output. • Previous Chapter- We know about the effects of (r) on I and Change in AD. • Equilibrium- Output =AD and Md=Ms • Implicit assumption of Keynesian at any level of output –given price level. AS horizontal. Refer to 8.1.

  3. AS Horizontal • How about if output below capacity of economy? Eg. Recession????? • Increase output might not put upward pressure on the level of money wage – given high level of employment. • MR labour not fall because more labour is employed – low level of employment. • So the cost of producing one unit output might remain constant even with increases in output.

  4. AS upward sloping • In normal situation, Increased in Y put more pressure on both wage and price levels. AS would upward sloping. • Output and price will be jointly determined by supply and demand factor. We discuss this later..

  5. AD schedule • Factor determined- AD • Factors determined changes in IS and LM. • Interest rate and money market. • Determined AS- find the output demanded for each price level. • To do this- examine how the position of IS and LM schedules.

  6. AD schedule • IS and LM intersect is point of AD. • Any changes along the IS schedule, change in AD. • To do this assume that G and T are fixed and not influence by price. The level of I (investment) assume fixed. Changes in Price do not directly effects I, but changes in r will affects the I.

  7. AD schedule • LM- Money market. • As long as price is constant, no need to determined the changes in real and nominal. • People will hold certain amount of money balance from transaction-where income is proxy for the real volume of transaction.

  8. AD schedule • Consequently, Equilibrium in money market occurs when the demand for real money is just equal to money supply. • Any changes in price will affects real money supply and shifts the LM schedule. • Figure 8.2

  9. AD schedule • AD reflects monetary influences- factor effects AD as well as direct influences on AD. • Factors that increase the level of equilibrium in the IS and LM model- increase the level of output demanded at given price level. – shift the AD to the Right.

  10. AD schedule • Consider the increase in Ms from Mo to M1. Refer to Figure 8.3. • This is an increase in income and aggregate demand that results at a given price level. • Price fixed at P0 different with figure 8.2 • Shift in AD = changes in equilibrium income IS-LM model.

  11. Question • Explain why the Keynesian AD is downward sloping when plotted against the price level.

  12. Answer • An increase in the price level reduces the real money stock. As a consequence, the interest rate must rise to lower real money demand and re-equilibrate the money market. (The LM schedule shifts up.) The rise in the interest rate lowers investment and, therefore, aggregate demand. Hence the aggregate demand curve portrays all combinations of output and prices such that both the money and product markets are in equilibrium

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