Review of the textbook Keynesian

model of Aggregate Demand

Presented By:

Muhammad Yasir Anwar

According to classicals

Keynesian Model Of AD and AS

What is Aggregate Demand

In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels.

Contd...

•The AD curve summarizes the demand side of the economy, which includes the Goods Market (IS) and the Money Market (LM). AD is derive from two familiar curves in output- interest space, the IS and LM curves.

The IS curve:

The IS curve shows the combinations of output and interest rate such that planned and actual expenditures on output are equal.

How the determinants of Planned Expenditure enters:

Where,

C = f(Y)

I = f(r)

Keynesian Cross

Explanation of graph:

• If one treat good that a frim produces and then hold as inventories as purchase by firm then all output is purchased by someone. Thus the actual expenditure equals economy output Y.

E = Y

• In equilibrium planned and actual expenditures must be equal so

IS Curve from Keynesian Cross

An increase in the interest rate shift the planned expenditure line down and thus reduces the level of income at which actual and planned expenditure are equal, and increase in the interest rate, IS curve slope downward.

Deriving IS from Keynesian Cross

Slope of IS:

• It implies that IS curve is flatter when either

• The larger the effect of interest rate on planned

expenditure, the larger the downward shift of the planned expenditure line and thus the larger the fall in output.

• Similarly, the steeper the planned expenditure the more output must fall in response to a downward shift of planned expenditure line.

The LM Curve:

• The LM curve shows the combination of output and interest rate that leads to the equilibrium in the money market for a given price level.

• Where money is high powered money which includes currency and reserves issued by the government. High powered money pays no interest the opportunity cost of holding money is the nominal interest.

The derivation Of LM Curve LM curve is derived from money market i.e Md and Ms

Slope of LM:

• Increase in the income elasticity of money demand and decrease in the interest elasticity of money demand make LM curve steeper.

The AD Curve:

• The intersection of IS and LM curves shows the values of i and Y such that the money market clears and actual and planned expenditures are equal for given level of M,P,G,T and Expected inflation.

• Now to see how IS and LM derive AD showing downward sloping relationship between P and Y. Assume a lower value of price.

Derivation of AD curve:

Slope of AD:

• Slope of AD comes from differentiating IS and LM equations.

• Since the expression is negative so the slope of AD is negative.

The effect of an increase in Government Purchases:

Conclusion:• The impact of any change in Aggregate Demand on

output and the price level depends on the Aggregate Supply curve. So according to Keynesian Theory if the AS is upward slopping both output and the price level increase.

Thanks