1. 3rd Lecture: macroeconomic fluctuations, traditional Keynesian theory
National and Kapodistrian University of Athens
Department of Economics
Master Program in Applied Economics
UADPhilEcon
Keynesian theories
3rd Lecture: macroeconomic fluctuations, traditional Keynesian theory
Nikolina Kosteletou

2. Basic assumptions and characteristics
Prices and wages are not perfectly flexible.
Nominal stickiness
Nominal rigidities
Slow-moving nominal adjustments →real effects on output and employment.

3. Keynesian models: basic relationships among aggregates Static models
Demand side is important (goods market, money market – effective demand)
Supply side (labor market, employment, output)

4. Keynesian models From the Keynesian cross to the IS-LM model
From the IS-LM to the AD-AS model.

5. Aggregate Demand and SupplyAS AD Y

6. From the Keynesian cross to the IS-LM
Keynesian cross: demand side (no money)
Real values matter
Prices are constant
Planned and actual expenditure
Expenditure - output
Equilibrium
E: planned real expenditure

7. equilibrium E: planned real expenditure.
In equilibrium planned expenditure is equal to actual expenditure.
Actual expenditure is equal to output, Y.
In equilibrium planned expenditure is equal to the economy’s output.
E=Y
If actual expenditure is greater than planned → inventories.
Firms cut their production.
→ Keynesian cross

8. Keynesian cross E
E=Y E A
45o Y

9. Planned expenditure E Components: C, I, G (closed economy) C=C(Y-T)
I=I(i-πe)
G, T exogenous
Standard specification of E:
E=C(Y-T) + I(i-πe) + G

10. General specification of planned expenditure
E = E(Y, (i-πe), G, T)
Assumptions about the effect of changes of determinants of components, on expenditure:
0<EY<1,
Ei-πe <0,
EG>0,
ET<0.

11. IS
Relates Y and i for which planned expenditure is equal to actual expenditure.
The slope of the IS is negative:
Y=E(Y, (i-πe), G, T)
dY/di=(∂E/ ∂ Y)∙(dY/di) +(∂ E/ ∂(i-πe)) ∙(d(i-πe) /di) ⇒
dY/di=(∂ E/ ∂ Y)∙(dY/di) + Ei-πe
dY/di= Ei-πe /1-EY <0

12. dY/di= Ei-πe /1-EY Slope of IS: di/dY= (1-EY)/ Ei-πe <0
the is flatter
The larger is EY and the larger is Ei

13. i E
E=Y E A
45o Y Y

14. LM
Combinations of Y and i that lead to equilibrium the money market for a given price level.
Money: high powered money (currency and reserves issued by authorities)
(money base, reserve money)

17. Demand for real money balances
(M/P)d=L(i,Y)
Li<0, Ly>0
(M/P) d=(M/P) s=M/P
Slope of the LM
di/dy

18. d (M/P)/di = (∂L/ ∂i)(di/di) + (∂L/ ∂Y)(dY/di) ⇒
(M/P)=L(i,Y)
Slope of the LM:
d (M/P)/di = (∂L/ ∂i)(di/di) + (∂L/ ∂Y)(dY/di) ⇒
0= (∂L/ ∂i) +(∂L/ ∂Y)(dY/di)
0 = Li + Ly(dY/di) )(dY/di) ⇒
dY/di = -Li/Ly >0

19. i LM Y

20. dY/di = -Li/Ly >0 LM steeper: the larger is Ly (classical case)
the smaller is Li
LM flatter: the smaller is Ly
the larger is Li (Keynesian case)

21. Elasticity of the demand for money
With respect to income:
(d(M/P)/M/P)/(dY/Y)
%(M/P)/%Y
dln(M/P)/dlnY
=0 (flat LM) i
dY/di = -Li/Ly >0 LM Y

22. Elasticity of the demand for money
With respect to the interest rate:
(d(M/P)/M/P)/(di/i)
%(M/P)/%i
dln(M/P)/dlni
=0 (vertical LM) i LM
dY/di = -Li/Ly >0 Y