Macro Final Topic Review

Savings & Leakage

Economic Schools of Thought

DEMAND FOR MONEY

MS

MD

NominalInterestRate

Qty $

Money Market

Demand for Money:

Transactions DemandPrecautionary DemandSpeculative Demand

Price Level changes shifts Demand Curve for Money↑ Px level shifts MD right↓Px level shifts MD left

You usually do not have to shift MDThe Fed. Controls MS and that moves with monetary policy

HOWEVER- sometimes they shift MD on the examFor example:1) If the stock market crashes—people hold moreMoney (precautionary demand) and MD shifts right2) If the price level ↑, then MD shifts right

Injections & Leakages

• Injections - income of firms which does not normally arise from the expenditure of households – changes in investment, government spending or exports.

• Leakages - Income not passed on by consumers in the circular flow – savings, taxation or imports

GDP Leakage

• GDP = Y = C + I + G + (X – M)

• Leakage to GDP: S + T + M (S = Savings T= taxes M = Imports)

• Injections to GDP: I + G + X (Investment, Gov’t, Exports)

• In equilibrium: Leakage = InjectionsS + T + M = I + G + X

Savings must end up asInvestment

Leakage Injections

Tariffs & Quotas

Revenue Tariff - designed to raise revenueProtective Tariff – designed to protect domestic marketQuotas- limit # of goods imported

D

S

-------------------------

P

USMarket(Wheat)

Price

World Price: when below domestic price we import

World Price: when above domestic price we export

Tariffs & Quotas:• will always produce deadweight loss and lower consumer surplus• lead to higher prices & protect inefficient producers

D

Sdomestic

-------------------------

P

World Qty(Wheat

Price

SWorld

STariff

Phillips Curve Short & Long Run

Natural rate ofunemployment

Long-run Phillipscurve

UnemploymentRate

0

InflationRate

The Phillips Curve

B

A

3. . . . andincreases theinflation rate . . .

UnemploymentRate (percent)

0

InflationRate

(percentper year)

(b) The Phillips Curve

Phillips curve

(output is8,000)

B

4

6

(output is7,500)

A

7

2

You may have to draw a Phillips CurveRemember—Unemployment on x-axis

House ofMoney

Dollar Priceof a Euro

Qty of Euros

D1D1

S1S1

----------------------------

1.43 Dollars

Q1

Market for EurosEuro Priceof a dollar

Qty of Dollars

D1D1

S1S1

----------------------------

.70 Euro

Q1

Market for Dollars

1) If real interest rates rise in the USA, then the dollar appreciatesa) Europeans supply Euros and demand dollars

2) If the price level rises in the USA, then the dollar depreciatesa) European goods look “cheap” => supply dollars demand Euros

Economic Schools of Thought

• Classical View• Markets are naturally self regulating (No Gov’t intervention)• Recessions are temporary, Wages & Prices are flexible

• Keynesian View• Economy is inherently unstable, Not self regulating• Wages & prices are sticky (Gov’t intervention needed)

• Monetarist View• Money matters!----do not regulate economy—control inflation

• Supply Side View• Incentives matter! Create incentives to increase LRAS