Constructing AD
The
AD from IS-LM
1. Price levels are
increased, with P0<P1<P2.
2. LM shifts to the left with
increasing P because real
money balances decline.
LM(P2)
LM(P1)
LM(P0)
r2
r1
r0
IS
Y2
Y1
Y0
P2
P1
P0
AD
Y2
Y1
Y0
Constructing AS
To
wage change
factors:
AS from
IS-LM
P
w0
AS
w/p
Nd
Y=F(N,K)
8
NOTES:
1.
2.
3.
4.
w0
Employment and
output result from
AD increases.
That is, labor
demand is derived
demand. Firms
employ labor based
upon conditions in
the aggregate goods
and services market.
AD
AD2
AD0
w/p
AD1
Y Y
(w/p)
AS
N
Nd
Y=F(N,K)
9
LM
IS
P
w0
IS LM I *, S *, M *,Y *, r *
C * C(Y T0 )
AD C I G0
AS Y *
1
N * F (Y *, K 0 )
d
Y
AS
AD
w/p
N s N s (w 0 / p ) N d * (w 0 / p ) *
w0
P*
w0 / P
Nd
Y=F(N,K)
10
LM0
r
IS
P
w0
Y
AS
AD1
AD0
LM1
Y
N
Nd
Y=F(N,K)
11
Policy: Increase in
Government Spending
(no Tax Increase)
1. IS Curve is shifted to the
right. Interest rates rise.
LM
r
r
IS0
P
w0
2. AD = C + I + G rises (shifts
to right).
3. Firms see higher prices,
increased demand, and
lower real wages, so they
increase output by
increasing employment.
IS1
Y
AS
AD1
AD0
w/p
N
Nd
Y=F(N,K)
12
Aggregate Supply:
Improvement in
Production Technology
1. Production function swings
outward, shifting AS curve to
the right.
2. Aggregate price level falls,
real money supply increases,
so LM Curve is shifted to the
right (neg. intercept is
increased)
3. Firms see higher real wages
and increased productivity,
so they decrease employment.
LM0
LM1
r
IS
P
w0
Y
AS
AD0
w/p
Y
N
Nd
Y=F(N,K)
13
Liquidity Trap
r
r
Ms
S(Y)
S>I
r*
Md
M*
I
14
Investment Trap
r
r
Ms
S(Y)
S>I
r*
Md
M*
r*
I
15
r
r1
P
P1
P0
AD1
AD0
Y
r0
IS+G
IS
Y*
Y
16
LM(P0)=LM(P1)
P1
P0
r0=r1
AD1
AD0
Y
IS+G
IS
Y0=Y1
M0 M1
P0
P1
Y
17