1. Chapter 3. Open Economy Macroeconomics
Aggregate Demand:
IS – LM Models
Aggregate Supply:
Fixed Prices, Flexible Prices and Sticky Prices

2. Derivation of IS Curve for AD
Y = C + I + G + NX
Where;
Y = real national income
C = expenditure on consumption
I = expenditure on investment
G = net government purchases of goods and services
NX = net exports (exports minus imports)
If we subtract C, I, and NX from both sides, we get:
S – I – NX = G

3. Real Exchange Rate by + zr = G0 + hQ0 Components of AD:
by + zr – hQ = G0
by + zr = G0 + hQ0
by0 + zr0 = G0 + hQ0

4. The IS Curve

5. The LM Curve Definitions of Money
M1 = currency in circulation + checkable deposits
M2 = M1 + noncheckable savings deposits + MMDA + small time deposits + MMMFs
M3 = M2 + large time deposits
MMDA = money market deposit accounts
MMMF = money market mutual funds
Near monies: M2 and M3
Small time deposits: less than 100,000 US$ in USA
Large time deposits: 100,000 US$ or more in USA

6. Demand For Money
Md = kY k > 0
Y = Py
Md = k Py

7. Government Budget Constraint
G – T = the budget deficit = total government spending
G – T = MB + BS

8. Money Supply in an Open Economy
FX + DC = (MB – MBb) + D FX + DC = MBp + D FX + DC = MS
Where:
FX = gold and foreign currency reserves
DC = domestic credit (L + LG)
L: loans advanced to personal and corporate sector by commercial banks
LG: lending to government by central bank
MB = currency issued (monetary base)
MBb = currency plus deposits with central bank
MBp = currency in circulation D = deposits by public MS = money supply
FX + DC = MS

9. The LM Curve

10. The LM Curve

11. Aggregate Demand
IS curve : by + zr = G0 + hQ0
LM curve : k,l > 0

12. AD Curve

13. AS: Flexible Prices

14. AS: Fixed Prices

15. AS: Sticky Prices