Perhaps the most important concept in macroeconomics is Gross Domestic Product (GDP): Gross Domestic Product (GDP) is defined as the market value of all finished goods and services produced in a country during a certain period of time.

Wage inflation

In this article, we will continue to develop the Keynesian model removing the assumption of fixed nominal wages. We define wage inflation πw as the percentage average increase in wages. Wages and wage inflation are still exogenous, i.e. they are not determined within the model. One justification for this assumption is that wages often are determined by agreements which often last for several years.

The problem with the IS-LM model

The starting point of the Aggregate Demand - Aggregate Supply or AD-AS model is an assumption in the IS-LM model (and in the cross model) that limits its usefulness. This is the assumption that if firms where to choose the profit maximizing quantity of L (LOPT), they would produce more than the aggregate demand. In the IS-LM, YOPT > YD must hold as discussed in section Aggregate supply.

To realize why this is a problem in the IS-LM model, we gradually increase the aggregate demand byincreasing G. We can illustrate the process using figure 12.6 in Section The Labor Market

The Keynesian model

In this chapter we will look at the Keynesian cross model. This model is a simple version of what we call the ”complete Keynesian model” or simply the Keynesian model. The Keynesian model has as its origin the writings of John Maynard Keynes in the 1930s, particularly the book ”The general theory of Employment, Interest, and Money”.

The main difference between the cross model and the investment saving, liquidity preference money supply (IS-LM)  model is that the nominal interest rate is exogenous in the cross model but endogenous in the IS-LM model. In this chapter we will explain how the nominal interest rate is determined in the IS-LM. P remains exogenous and constant in the IS-LM model.

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