PRINCIPLES OF MACROECONOMICS PART III The Core of Macroeconomic Theory TENTH EDITION CASE FAIR OSTER © 2012 Pearson Education, Inc Publishing as Prentice Hall Prepared by: Fernando Quijano & Shelly ofTefft 59 PART III The Core of Macroeconomic Theory © 2012 Pearson Education, Inc Publishing as Prentice Hall of 59 Aggregate Demand in the Goods and Money Markets 12 CHAPTER OUTLINE Planned Investment and the Interest Rate Other Determinants of Planned Investment Planned Aggregate Expenditure and the Interest Rate Equilibrium in Both the Goods and Money Markets: The IS-LM Model PART III The Core of Macroeconomic Theory Policy Effects in the Goods and Money Markets © 2012 Pearson Education, Inc Publishing as Prentice Hall Expansionary Policy Effects Contractionary Policy Effects The Macroeconomic Policy Mix The Aggregate Demand (AD) Curve The Aggregate Demand Curve: A Warning Other Reasons for a Downward-Sloping Aggregate Demand Curve Shifts of the Aggregate Demand Curve from Policy Variables Looking Ahead: Determining the Price Level Appendix: The IS-LM Model of 59 PART III The Core of Macroeconomic Theory goods market The market in which goods and services are exchanged and in which the equilibrium level of aggregate output is determined money market The market in which financial instruments are exchanged and in which the equilibrium level of the interest rate is determined © 2012 Pearson Education, Inc Publishing as Prentice Hall of 59 PART III The Core of Macroeconomic Theory Planned Investment and the Interest Rate FIGURE 12.1 Planned Investment Schedule Planned investment spending is a negative function of the interest rate An increase in the interest rate from percent to percent reduces planned investment from I0 to I1 © 2012 Pearson Education, Inc Publishing as Prentice Hall of 59 PART III The Core of Macroeconomic Theory Reducing the interest rate, ceteris paribus, is likely to: a Increase the level of planned investment spending b Decrease the level of planned investment c Shift the demand for money curve to the right d Shift the supply of money curve to the right © 2012 Pearson Education, Inc Publishing as Prentice Hall of 59 PART III The Core of Macroeconomic Theory Reducing the interest rate, ceteris paribus, is likely to: a Increase the level of planned investment spending b Decrease the level of planned investment c Shift the demand for money curve to the right d Shift the supply of money curve to the right © 2012 Pearson Education, Inc Publishing as Prentice Hall of 59 Planned Investment and the Interest Rate Other Determinants of Planned Investment The assumption that planned investment depends only on the interest rate is obviously a simplification, just as is the assumption that consumption depends only on income PART III The Core of Macroeconomic Theory In practice, the decision of a firm on how much to invest depends on, among other things, its expectation of future sales The optimism or pessimism of entrepreneurs about the future course of the economy can have an important effect on current planned investment Keynes used the phrase animal spirits to describe the feelings of entrepreneurs, and he argued that these feelings affect investment decisions © 2012 Pearson Education, Inc Publishing as Prentice Hall of 59 ECONOMICS IN PRACTICE Small Business and the Credit Crunch PART III The Core of Macroeconomic Theory We know how a firm’s investment decisions depend on the interest rate In the recession of 2008–2009 some firms—especially small ones—were discouraged from investing, not by high interest rates, but by the general unwillingness of banks to lend them money at all Bailout Missed Main Street, New Report Says The Wall Street Journal © 2012 Pearson Education, Inc Publishing as Prentice Hall of 59 Planned Investment and the Interest Rate Planned Aggregate Expenditure and the Interest Rate We can use the fact that planned investment depends on the interest rate to consider how planned aggregate expenditure (AE) depends on the interest rate Recall that planned aggregate expenditure is the sum of consumption, planned investment, and government purchases PART III The Core of Macroeconomic Theory That is, © 2012 Pearson Education, Inc Publishing as Prentice Hall AE ≡ C + I + G 10 of 59 ... Hall of 59 PART III The Core of Macroeconomic Theory Reducing the interest rate, ceteris paribus, is likely to: a Increase the level of planned investment spending b Decrease the level of planned... The Core of Macroeconomic Theory In practice, the decision of a firm on how much to invest depends on, among other things, its expectation of future sales The optimism or pessimism of entrepreneurs... interest rate In the recession of 2008–2009 some firms—especially small ones—were discouraged from investing, not by high interest rates, but by the general unwillingness of banks to lend them money