Page 150 - Macroeconomics. book docx_Neat

Equilibrium occurs where aggregate

expenditure equals total output (the 45-degree line). Changes in consumption,

investment, government spending, or net exports

shift the aggregate expenditure line and lead to changes in equilibrium income.

4. Inflationary and Recessionary Gaps:

An inflationary gap occurs when aggregate expenditure exceeds the level of output at
full employment, leading to upward

pressure on prices. A recessionary gap occurs when aggregate expenditure is insufficient

to achieve full employment, resulting

in unemployment and unused resources. These gaps justify government intervention

through fiscal policy.

5. Aggregate Supply (Classical):

The classical aggregate supply curve is vertical at the level of full employment output. It
assumes prices and wages are

flexible in the long run, so output is determined by real factors rather than demand.

6. IS Curve:

The IS curve represents equilibrium in the goods market. It shows an inverse
relationship between income and the interest rate.

Higher interest rates reduce investment, leading to lower output, while lower interest

rates stimulate investment and increase income.

7. LM Curve:

The LM curve represents equilibrium in the money market. It shows a positive

relationship between income and the interest rate.

As income increases, demand for money rises, leading to higher interest rates for a
given money supply.

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