Chapter 20: IS Curve Flashcards
aggregate demand
the total amount of output demanded in the economy
AD/AS model
model used to explain SR fluctuation in aggregate output
IS curve
describes the relationship between real interest rates and aggregate output when the market for goods and services is in equilibrium
- investment = savings
planned expenditures
the total amount that households, businesses, the government, and foreigners wants to spend on domestic goods and services
- planned expenditure = AD
actual expenditure
the amount that households, businesses, the government, and foreigners actually spend
- actual expenditures = real/actual Y
Four types of spending
- Consumption expenditure
- Planned investment spending
- government purchases
- net exports
disposable income (Y_D)
total amount of income available for spending
- Y_D = Y-T
consumption function
C = constant C + mpc * Y_D
marginal propensity to consume (mpc)
the change in consumption expenditure from an additional dollar of disposable income
autonomous consumption expenditure (constant C)
the amount of consumption expenditure that is exogenous
- related to optimism about future income and HH wealth
exogenous
independent of variables in the model
Two types of investment spending
fixed and inventory
inventory spending
planned spending by firms on additional materials/goods in terms of the change in holding these materials/goods
- some unplanned
fixed investment
planned spending by firms on equipment and structures
- fixed > inventory
planned investment spending and real interest rates
when real interest rates for investments/the cost of borrowing are low, planned investment spending increases
planned investment spending equation
Planned investment spending = fixed investment + planned inventory investment
autonomous investment (constant I)
a component of planned investment spending that is completely exogenous which is influenced by optimism/pessimism
investment function
I = constant I - dr_i
I = constant I - d(r + constant f)
dr_i
responsiveness of investment to the real interest rate for investment
financial frictions (constant f)
additions to the real cost of borrowing caused by barriers to financial markets
credit spread
interest rate on loans to business - interest rate on safe assets
two ways government spending affects aggregate demand
purchases and taxes
how does taxes affect AD?
affects disposable income
two components of net exports
autonomous net exports and the part of net exports that is affected by changes in real interest rates
real interest rates and net exports
a rise in the real interest rate leads to an increase in the value of the dollar which leads to a decline in net exports
autonomous net exports (constant NX)
the level of net exports
net export function
NX = constant NX - xr
x
how net exports respond to the real interest rate
IS curve equation
Y = [C + I - df + G + NX - mpc * T] * 1/1-mpc - (d+x)/(1-mpc) * r
why the economy heads towards equilibrium
- excess supply of good causes firms to cut production
- excess demand for good causes firms to increase production
six autonomous factors that shift AD
- government purchases
- change in taxes
- changes in autonomous spending
- changes in financial friction
AD shifts from government purchases
- increase in purchases causes right shift
- decrease in purchases causes left shift
AD shifts from taxes
- rise in taxes causes left shift
- cut in taxes causes right shift
AD shifts from autonomous consumption
- rise in consumption causes right shift
- fall in spending causes left shift
AD shifts from autonomous investment spending
- increase in investment spending causes right shift
- decrease in investment spending causes left shift
AD shifts from net exports
- increase in net exports causes right shift
- decrease in net exports causes left shift
AD shifts from financial frictions
- increase in frictions causes left shift
- decrease in frictions causes right shift
Animal spirits
unstable exogenous fluctuations influence by emotional waves of optimism and pessimism
unplanned inventory investment and output
increase in unplanned inventory investment equals excess output over aggregate demand
excess supply and aggregate output
excess supply when aggregate output is right of IS curve and will cause a fall in output
excess demand and aggregate output
excess demand when aggregate output is left of IS curve and will cause a rise in output
