Page 82 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 4: Theories of Income, Output and Employment: Keynesian Theory

Figure 4.11 Notes
Y
Overall
Price
Level
(P)

AD 0
AD 1
X X
O Agg. Income
(Y)
Suppose money supply (Ms) is increased. The AD curve will shift to the right because of the
following changes:
Rise in Ms makes the existing Md less than Ms at the existing rate of interest(r). To get rid
of surplus money people start buying bonds. In this environment companies issue new
bonds at a lower r. Thus rise in Ms leads to fall in r.
Fall in r leads to rise in investment.

Fall in r also leads to rise in C.
Rise in both C and I increases AE.
Increase in AE shift AD curve to the right (Figure 4.10).
Now suppose Net Taxes (T) are reduced. Net taxes mean taxes less transfer payments. This also
leads to shift of AD curve to the right. How?
Reduction in T leads to rise in disposable income (Yd)
Rise in Yd raises C.

Rise in C raises AE.
Rise in AE shifts AD curve to the right.
Suppose Government Rises G. Rise in G also leads to shift of the AD curve to the right due to the
following.
Rise in G raises AE
Rise in AE shifts AD curve to the right.
The same kind of reasoning applies to decrease in Ms, increase in T, and decrease in G
leading to the shift of the AD curve to the left (Figure 4.11).

Case Study Composition of AD in Times of Slowdown

he slowdown had taken a big hit on the private consumption whose contribution
to GDP growth reduced to half from 53.8% of GDP in 2007-08 to 27% in 2008-09,
Twhile that of government has increased four times from 8% to 32.5% in the same
period.

Contd...

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