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Money
Velocity
V =
P Y
M
Equation of Exchange
M V = P Y
Change in Velocity
from Year to Year:
19152002
Cambridge Approach
Is velocity constant?
1. Classicals thought V
constant because didnt
have good data
2. After Great Depression,
economists realized
velocity far from constant
Keyness Liquidity
Preference Theory
3 Motives
1.Transactions motiverelated to Y
2.Precautionary motiveconstant
3.Speculative motive
A. related to W and Y
B. negatively related to i
Liquidity Preference
P
Md
=
f(i, Y)
+
Keyness Liquidity
Preference Theory
1
=
f(i,Y)
PY
=
M
Y
=
f(i,Y)
i , f(i,Y) , V
Change in expectations of future i or change
f(i,Y) results in a change in V
Determination of Output
Keynesian IS-LM Model assumes price level is fixed
Aggregate Demand
Yad = C + I + G + NX
Equilibrium
Y = Yad
Consumption Function
C = a + (mpc YD)
Investment
1.
Fixed investment
2.
Inventory investment
Only planned investment is included in Yad
Consumptio
n
Function
Assume G = 0, NX = 0, T
= 0
Yad = C + I = 200 + .5Y
+ 300 = 500 + .5Y
Equilibrium:
1. When Y > Y*, Iu > 0
Y to Y*
2. When Y < Y*, Iu < 0
Y to Y*
8
Expenditure Multiplier
Analysis of Figure 3:
Expenditure Multiplier
I = + 100 Y/I = 200/100 = 2
1
Y = (a + I)
1 mpc
A = a + I = autonomous spending
Conclusions:
1.Expenditure multiplier = Y/A = 1/(1
mpc)
whether change in A is due to change in
a or I
2. Animal spirits change A
Role of Government
Analysis of Figure 5:
Role of Government
G = +
1. With
.5Y,
2. With
400, T = + 400
no G and T, Yd = C + I = 500 + mpc Y = 500 +
Y1 = 1000
G, Y= C + I + G = 900 + .5Y, Y2 = 1800
3. With G and T, Yd = 900 + mpc Y mpc T = 700
+ .5Y, Y3 = 1400
Conclusions:
1. G Y ; T Y
2. G = T = + 400, Y 400
Role of International
Trade
NX = +100,
Y/NX = 200/100 = 2
= 1/(1 mpc) = 1/
(1 .5)
Summary:
Factors
that
Affect Y
IS
Curve
IS curve
1. i I NX
, Yad , Y
Points 1, 2,
3 in figure
2. Right of IS:
Y > Yad Y
to IS
Left of IS:
Y < Yad Y
to IS
16
Preference
Framework to Loanable
Funds
Keyness Major Assumption
Two Categories of Assets in Wealth
Money
Bonds
1. Thus:
Ms + Bs = Wealth
Ms + Bs = Bd + Md
Liquidity Preference
Analysis
Derivation of Demand
Curve
Money
Market
Equilibri
um
1. Income , Md , Md
shifts out to
right
2. Ms unchanged
3 i* rises from i1 to
i2
1. Ms , Ms shifts
out to right
2. Md unchanged
3. i* falls from i1
to i2
Factors
that
Shift
Money
Demand
and
Supply
Curves
LM Curve
LM curve
1. Y , Md , i
Points 1, 2, 3 in figure
d
2. Right of LM: excess M , i to LM
Left of LM : excess Ms, i to
LM
24
ISLM
Mode
l
Point E,
equilibrium where
Y = Yad (IS) and
Md = M s (LM )
At other points
like A, B, C, D,
one of two
markets is not in
equilibrium and
arrows mark
movement towards
point E
Shift
in
the
IS
Curve
1. M
Response to an Increase in
s
M
1. M s : i , LM shifts
right Y i
Response to Expansionary
Fiscal Policy
1. G or T : Yad , IS
shifts right Y i
Summary
:
Factors
that
Shift
IS and
LM
Curves
Effective
ness of
Monetary
and
Fiscal
Policy
1. M d is unrelated to i i , M d
= M s at same Y LM vertical
2. Panel (a): G , IS shifts right
i , Y stays same (complete
crowding out)
3. Panel (b): M s , Y so M d , LM
shifts right i Y
Conclusion: Less interest
sensitive is M d, more effective
is monetary policy relative to
fiscal policy
32