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Aggregat Demand

Team Teaching
Dept. Islamic Economics
Faculty of Economics and
Business
Airlangga University
In this session, you will learn…
• how to derive the aggregate demand
curve from the IS-LM model
Equilibrium in the IS -LM model
The IS curve represents r
equilibrium in the goods LM
market.
Y  C (Y  T )  I (r )  G
r1
The LM curve represents money
market equilibrium.
M P  L (r ,Y ) IS
Y
Y1
The intersection determines
the unique combination of Y and r
that satisfies equilibrium in both markets.
IS-LM and aggregate demand
• So far, we’ve been using the IS-LM model to
analyze the short run, when the price level is
assumed fixed.
• However, a change in P would
shift LM and therefore affect Y.
• The aggregate demand curve
captures this relationship between P and Y.
Deriving the AD curve
r LM(P2)
Intuition for slope LM(P1)
r2
of AD curve:
r1
P  (M/P )
IS
 LM shifts left Y2 Y1 Y
P
 r
P2
 I
P1
 Y AD
Y2 Y1 Y
Monetary policy and the AD curve
r LM(M1/P1)
The Fed can increase LM(M2/P1)
aggregate demand: r1
r2
M  LM shifts right
IS
 r
Y1 Y2 Y
P
 I
 Y at each P1
value of P
AD2
AD1
Y1 Y2 Y
Fiscal policy and the AD curve
r LM
Expansionary fiscal policy
(G and/or T ) increases r2
agg. demand: r1 IS2
T  C IS1
Y1 Y2 Y
 IS shifts right P
 Y at each
P1
value of P
AD2
AD1
Y1 Y2 Y
IS-LM and AD-AS
in the short run & long run
The force that moves the economy from
the short run to the long run
is the gradual adjustment of prices.

In the short-run then over time, the


equilibrium, if price level will
Y Y rise
Y Y fall

Y Y remain constant
The SR and LR effects of an IS shock
r LRAS LM(P1)
A
A negative
negative ISIS shock
shock
shifts
shifts IS
IS and
and AD
AD left,
left,
causing
causing Y Y to
to fall.
fall.
IS1
IS2
Y Y
P LRAS

P1 SRAS1

AD1
AD2
Y Y
The SR and LR effects of an IS shock
r LRAS LM(P1)

In
In the
the new
new short-run
short-run
equilibrium, Y  Y
equilibrium, IS1
IS2
Y Y
P LRAS

P1 SRAS1

AD1
AD2
Y Y
The SR and LR effects of an IS shock
r LRAS LM(P1)

In
In the
the new
new short-run
short-run
equilibrium, Y  Y
equilibrium, IS1
IS2
Y Y
Over
Over time,
time, PP gradually
gradually
falls,
falls, which
which causes
causes P LRAS

•• SRAS P1 SRAS1
SRAS toto move
move down.
down.
•• M/P
M/P to
to increase,
increase, which
which
causes
causes LM
LM AD1
to AD2
to move
move down.
down.
Y Y
The SR and LR effects of an IS shock
r LRAS LM(P1)
LM(P2)

IS1
IS2
Y Y
Over
Over time,
time, PP gradually
gradually
falls,
falls, which
which causes
causes P LRAS

•• SRAS P1 SRAS1
SRAS toto move
move down.
down.
•• M/P P2 SRAS2
M/P to
to increase,
increase, which
which
causes
causes LM
LM AD1
to AD2
to move
move down.
down.
Y Y
EXERCISE:
Analyze SR & LR effects of M
a. Draw the IS-LM and AD- r LRAS LM(M1/P1)
AS diagrams as shown
here.
b. Suppose Fed increases
M. Show the short-run IS
effects on your graphs.
Y Y
c. Show what happens in
the transition from the P LRAS
short run to the long run.
P1 SRAS1

AD1

Y Y
The Great Depression
240 30
Unemployment
220 (right scale) 25
billions of 1958 dollars

percent of labor force


200 20

180 15

160 10

140 Real GNP 5


(left scale)
120 0
1929 1931 1933 1935 1937 1939
THE SPENDING HYPOTHESIS:
Shocks to the IS curve
• asserts that the Depression was largely due to
an exogenous fall in the demand for goods &
services – a leftward shift of the IS curve.
• evidence:
output and interest rates both fell, which is
what a leftward IS shift would cause.
THE SPENDING HYPOTHESIS:
Reasons for the IS shift

• Stock market crash  exogenous C


• Oct-Dec 1929: S&P 500 fell 17%
• Oct 1929-Dec 1933: S&P 500 fell 71%
• Drop in investment
• “correction” after overbuilding in the 1920s
• widespread bank failures made it harder to
obtain financing for investment
• Contractionary fiscal policy
• Politicians raised tax rates and cut spending
to combat increasing deficits.
THE MONEY HYPOTHESIS:
A shock to the LM curve
• asserts that the Depression was largely due to
huge fall in the money supply.
• evidence:
M1 fell 25% during 1929-33.
• But, two problems with this hypothesis:
• P fell even more, so M/P actually rose slightly
during 1929-31.
• nominal interest rates fell, which is the opposite of
what a leftward LM shift would cause.
THE MONEY HYPOTHESIS AGAIN:
The effects of falling prices
• asserts that the severity of the Depression
was due to a huge deflation:
P fell 25% during 1929-33.
• This deflation was probably caused by the fall
in M, so perhaps money played an important
role after all.
THE MONEY HYPOTHESIS AGAIN:
The effects of falling prices

• The stabilizing effects of deflation:


 P  (M/P )  LM shifts right  Y
• Pigou effect:
P  (M/P )
 consumers’ wealth 
 C
 IS shifts right
 Y
THE MONEY HYPOTHESIS AGAIN:
The effects of falling prices
• The destabilizing effects of expected deflation:
 e
 r  for each value of i
 I  because I = I (r )
 planned expenditure & agg. demand 
 income & output 
THE MONEY HYPOTHESIS AGAIN:
The effects of falling prices

• The destabilizing effects of unexpected


deflation:
debt-deflation theory
P (if unexpected)
 transfers purchasing power from borrowers to lenders
 borrowers spend less,
lenders spend more
 if borrowers’ propensity to spend is larger than
lenders’, then aggregate spending falls,
the IS curve shifts left, and Y falls
Why another Depression is unlikely

• Policymakers (or their advisors) now know


much more about macroeconomics:
• The Fed knows better than to let M fall
so much, especially during a contraction.
• Fiscal policymakers know better than to raise taxes or
cut spending during a contraction.

• Federal deposit insurance makes


widespread bank failures very unlikely.
• Automatic stabilizers make fiscal policy
expansionary during an economic downturn.
Summary

1. IS-LM model
• a theory of aggregate demand
• exogenous: M, G, T,
P exogenous in short run, Y in long run
• endogenous: r,
Y endogenous in short run, P in long run
• IS curve: goods market equilibrium
• LM curve: money market equilibrium

slide 23
Summary

2. AD curve
• shows relation between P and the IS-LM
model’s equilibrium Y.
• negative slope because
P  (M/P )  r  I  Y
• expansionary fiscal policy shifts IS curve right,
raises income, and shifts AD curve right.
• expansionary monetary policy shifts LM curve
right, raises income, and shifts AD curve right.
• IS or LM shocks shift the AD curve.

slide 24
Kurva Permintaan Agregat dalam
Islam
• Perubahan tingkat harga akan mempengaruhi
keseimbangan melalui pengaruhnya terhadap
penawaran uang riil. Jumlah penawaran uang riil adalah
:
M’s = Ms
P
dimana :
Ms adalah penawaran uang nominal dan P adalah
tingkat harga.
• Kenaikan tingkat harga akan menurunkan penawarab
uang riil, dan sebaliknya penurunan tingkat harga akan
meningkatnkan penawaran uang riil
• Pada ekonomi Islam, peningkatan penawaran
uang riil karena penurunan tingkat harga akan
meningkatkan jumlah uang tunai yang dipegang
oleh perorangan maupun oleh perusahaan.
• Kemudian mereka mengurangi jumlah uang tunai
dengan melakukan investasi agar zakat dan
biaya lainnya dibayar dari keuntungan usaha.
• Dengan demikian, investasi berhubungan dengan
tingkat keuntungan yang diharapkan, dan melalui
efek multiplier akan meningkatkan pendapatan
nasional.
• Sebagian uang yang diaktifkan diarahkan kepada
peningkatan konsumsi dan pendapatan nasional.
• Perubahan tingkat harga akan menimbulkan efek
Pigou terhadap perilaku perorangan, terutama
pada pengeluaran-pengeluaran konsumtif.
• Uang tunai merupakan bagian kekayaan
seseorang, tetapi berbeda dengan kekayaan fisik
lain yang niali nominalnya dapat naik atau turun
sesuai tingkat harga umum. Nilai nominal uang
adalah tetap sementara nilai riilnya bergerak
berlawanan arah dengan tingkat harga. Jika
tingkat harga akan turun maka jumlah uang
tunai riil akan meningkat, kekayaan meningkat,
keinginan konsumsi meningkat.(Asumsi
kekayaan mempengaruhi tingkat konsumsi)
• Penurunan harga umum akan meningkatkan upah
riil , dan ini akan meningkatkan konsumsi.
Peningkatan konsumsi selanjutnya meningkatkan
pendapatan nasional.
• Penurunan tingkat harga umum yang
menyebabkan kenaikan konsumsi mengakibatkan
kurva IS bergeser ke bawah dan mengakibatkan
kenaikan Y pada tingkat keuntungan yang
diharapkan tertentu (r0). Jadi penurunan tingkat
harga mengakibatkan kenaikan pendapatan
nasional, dan sebaliknya. Terdapat hubungan
terbalik antara tingkat harga dan pendapatan
nasional.Hubungan ini ditunjukkan oleh fungsi
permintaan agregat (D).
(a) (b)
C C

C1 I’=S

Co

45˚
Po P Co C
P1
IoSo
©
r I1S1

Y
(e)
P
P (d)

P1
P1

45˚ D
Y Y
Y1
• Gambar di atas menunjukkan penurunan
harga dari Po ke P1 berakibat pada
peningkatan C dari Co ke C1.
• Gambar b merupakan rancangan geometrik
yang memungkinkan memutar sumbu.
• Peningkatan konsumsi menggeser IS ke
kanan.
• Melalui menggabungkan gbr a dan b dapat
ditarik kurva permintaan agregrat D. Kurva ini
menunjukkan jika tingkat harga umum turun
Po ke P1 maka permintaan produksi nasional
meningkat dari Yo ke Y1.
• Jazakallah khoiron katsiro.