1. © 2008 Pearson Education Canada22.1 Chapter 22 The ISLM Model

2. © 2008 Pearson Education Canada22.2 Determination of Aggregate Output

3. © 2008 Pearson Education Canada22.3 Consumption Expenditure and the Consumption Function

4. © 2008 Pearson Education Canada22.4 Consumer Expenditure and the Consumption Function (Cont’d)

5. © 2008 Pearson Education Canada22.5 Consumption Function

6. © 2008 Pearson Education Canada22.6 Investment Spending Fixed investment—always planned Inventory investment—can be unplanned Planned investment spending –Interest rates –Expectations

7. © 2008 Pearson Education Canada22.7 The Keynesian Cross

8. © 2008 Pearson Education Canada22.8 Expenditure Multiplier A change in planned investment spending leads to an even larger change in aggregate output An increase in planned investment spending leads to an additional increase in consumer expenditure which raises aggregate demand and output further  Y  ( 1 1  mpc )  I  Y/  I  ( 1 1  mpc )

9. © 2008 Pearson Education Canada22.9 Response of Aggregate Output to a Change in Planned Investment

10. © 2008 Pearson Education Canada22.10 Response of Aggregate Output to a Collapse in Investment Spending

11. © 2008 Pearson Education Canada22.11 Changes in Autonomous Spending

12. © 2008 Pearson Education Canada22.12 Government’s Role

13. © 2008 Pearson Education Canada22.13 Response of Aggregate Output to Government Spending and Taxes

14. © 2008 Pearson Education Canada22.14 Role of International Trade

15. © 2008 Pearson Education Canada22.15 Response of Aggregate Output to a Change in Net Exports

16. © 2008 Pearson Education Canada22.16 Response of Aggregate Output to Changes in I, G, T, NX

17. © 2008 Pearson Education Canada22.17 The ISLM Model Includes money and interest rates in the Keynesian framework Examines an equilibrium where aggregate output equals aggregate demand Assumes fixed price level where nominal and real quantities are the same

18. © 2008 Pearson Education Canada22.18 IS curve is the relationship between equilibrium aggregate output and the interest rate LM curve is the combinations of interest rates and aggregate output for which M D = M S

19. © 2008 Pearson Education Canada22.19 Equilibrium in the Goods Market: The IS Curve Interest rates and planned investment spending –Negative relationship Interest rates and net exports –Negative relationship

20. © 2008 Pearson Education Canada22.20 The points at which the total quantity of goods produced equals the total quantity of goods demanded Output tends to move toward points on the curve that satisfies the goods market equilibrium

21. © 2008 Pearson Education Canada22.21 Deriving the IS Curve

22. © 2008 Pearson Education Canada22.22 Equilibrium in the Market for Money: The LM Curve Demand for money called liquidity preference M d /P depends on income (Y) and interest rates (i) Positively related to income –Raises the level of transactions –Increases wealth Negatively related to interest rates

23. © 2008 Pearson Education Canada22.23 Equilibrium in the Market for Money: The LM Curve (Cont’d) Connects points that satisfy the equilibrium condition that M D = M S For each level of aggregate output, the LM curve tells us what the interest rate must be for equilibrium to occur The economy tends to move toward points on the LM curve

24. © 2008 Pearson Education Canada22.24 Deriving the LM Curve

25. © 2008 Pearson Education Canada22.25 The ISLM Diagram: Determination of Output and the Interest Rate