Lecture 16
KEYNESIAN MODEL OF AN OPEN ECONOMY WITH PERFECT CAPITAL MOBILITY

1. The goods market

• AE = C + I + G + (X - IM)     (1)

• Aggregate expenditure rises with GDP (why?):
  AE-line has a positive slope

1.2 Equilibrium condition

• Y = AE     (2)

• Obtain eqbm value of GDP from equations (1) and (2)

• Intersection of AE-line and 45-degree line yields eqbm GDP

1.3 Changes in GDP

• Caused by changes in aggregate expenditure

• The AE-line will shift up due to:
  • Decrease in R
  • Decrease in T
  • Increase in G
  • Increase in E

2. The money market

• Nominal money demand:
  
  • Falls as R rises
  • Rises with GDP
  • Rises with the price level

• Nominal money supply:
  
  • Set by the central bank (independent of R)

2.2 Equilibrium condition

• M^d = M^s

• Obtain eqbm interest rate at intersection of M^d and M^s curves

2.3 Changes in interest rate

• Caused by shifts in money demand and money supply

• R will rise due to:
  
  • Increase in Y
  • Increase in P
  • Decrease in M^s

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