Lecture notes Macroeconomics CHAPTER 12 Aggregate Demand: Applying the IS-LM Model ISBN: 9781319263904
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Economics
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University Of Reading (UoR)
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Macroeconomics
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MACROECONOMICS CHAPTER 12: Aggregate Demand II: Applying the IS-LM Model
Macroeconomics 11th Edition By N. Gregory Mankiw
The Keynesian Cross– Planned Expenditure Actual expenditure
● The amount households, firms, and the
government spend on goods and services
● It equals the economy’s gross domestic product
(GDP)
Planned expenditure
● The amount households, firms, and the
government would like to spend on goods and
services
Why actual expenditure differs from planned
expenditure
● Firms can have unplanned inventory investment
when their sales do not meet their expectations.
○ If firms sell less than they planned, their
inventories automatically rise
○ If firms sell more than planned, their
inventories fall.
● Unplanned changes in inventory→ counted
as investment spending
○ Actual expenditure can be either above or
below planned expenditure.
The determinants of planned expenditure
● PE = C + I + G
● Full version: PE=C ¿
● Graphically:
● Planned expenditure PE depends on income
because higher income→ higher
consumption, which is part of planned
expenditure. The slope of the planned-
expenditure function is the marginal
propensity to consume MPC.
The Economy in Equilibrium The Economy in Equilibrium
● The economy is in equilibrium when:
○ Actual expenditure = planned expenditure
● This assumption is based on the idea that people
have no reason to alter their behavior when their
plans have been realized.
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