Chapter 10: Aggregate Demand I The IS-LM Model A short-run macroeconomic model which takes the price level constant and shows how changes in the level of Aggregate Demand cause changes in income The IS curve: The Keynesian Cross Theory The LM curve: The Liquidity Preference Theory Shift in Aggregate Demand An increase in the level AD increases the level of income, given the price level Price level P SRAS AD3 AD2 AD1 Y1 Y2 Y3 Output, Income The Keynesian Cross Equilibrium in the product market: Planned Expenditures: E = C(Y-T) + I + G Actual Expenditures: Y Aggregate Equilibrium: Y = C(Y-T) + I + G Total income = Total planned expenditures Aggregate Equilibrium Actual Expenditure: Y = E E Planned Expenditure: E=C+I+G Keynesian Cross Increase inventories Y2 Y Reduce inventories Y1 Y Adjustment to Equilibrium Y1> Y indicates an excess supply of goods in the market So, businesses accumulate inventories to reduce Y1 to Y Y2