ModulePutting it All Together

KRUGMAN'SMACROECONOMICS for AP*

45

Margaret Ray and David Anderson

What you will learnWhat you will learn

in thisin this ModuleModule::

• How to use macroeconomic models to conduct policy analysis

• How to approach free-response macroeconomics questions

Assume that the United Assume that the United States economy is in a States economy is in a long-run equilibrium.long-run equilibrium.(a)(a)Draw a correctly labeled Draw a correctly labeled long run graph of aggregate long run graph of aggregate demand and aggregate demand and aggregate supply and show each of supply and show each of the following for the United the following for the United States.States.

The current The current equilibrium output equilibrium output level, labeled Ye, level, labeled Ye, and the current and the current equilibrium price equilibrium price level, labeled PLe.level, labeled PLe.

A Structure for A Structure for Macroeconomic AnalysisMacroeconomic Analysis

1. A starting point

2. A pivotal event

3. Initial effects of the event

4. Secondary and long-run effects of the event

(b) (b) Suppose that Suppose that consumer confidence consumer confidence in the United States in the United States experiences a experiences a significant downturn. significant downturn. In the graph drawn in In the graph drawn in part (a), show the part (a), show the impact of weakened impact of weakened consumer confidence. consumer confidence. In the graph, show In the graph, show any changes to the any changes to the equilibrium price level equilibrium price level and the equilibrium and the equilibrium output level.output level.

A Structure for A Structure for Macroeconomic AnalysisMacroeconomic Analysis

1. A starting point

2. A pivotal event

3. Initial effects of the event

4. Secondary and long-run effects of the event

(c) (c) Assume that the Assume that the central bank of the central bank of the United States is United States is prepared to take action prepared to take action to reverse the economic to reverse the economic impacts shown in part impacts shown in part (b). (b). (i) Should the central (i) Should the central bank buy or sell bonds bank buy or sell bonds in an open market in an open market operation?operation?(ii) How does the (ii) How does the central bank’s action in central bank’s action in part (c)(i) affect the part (c)(i) affect the nominal interest rate? nominal interest rate? Explain.Explain.

A Structure for A Structure for Macroeconomic AnalysisMacroeconomic Analysis

1. A starting point

2. A pivotal event

3. Initial effects of the event

4. Secondary and long-run effects of the event

(d) (d) The United The United States and Mexico States and Mexico are major trading are major trading partners. How partners. How would the weak would the weak consumer consumer confidence in the confidence in the United States affect United States affect the balance of the balance of payments current payments current account with account with Mexico? Explain.Mexico? Explain.

A Structure for A Structure for Macroeconomic AnalysisMacroeconomic Analysis

1. A starting point

2. A pivotal event

3. Initial effects of the event

4. Secondary and long-run effects of the event

 (e) (e) Consider the foreign Consider the foreign exchange market for the exchange market for the United States dollar. United States dollar. Based only upon your Based only upon your response to part (d), response to part (d), how are each of the how are each of the following affected?following affected?

(i) The supply of the (i) The supply of the United States dollar United States dollar relative to the Mexican relative to the Mexican peso.peso.

(ii) The value of the (ii) The value of the dollar relative to the dollar relative to the peso.peso.

A Structure for A Structure for Macroeconomic AnalysisMacroeconomic Analysis

1. A starting point

2. A pivotal event

3. Initial effects of the event

4. Secondary and long-run effects of the event

The Starting PointThe Starting Point

•AD/AS Model

• Long-run macroeconomic equilibrium

• A recessionary gap

• An inflationary gap

The Pivotal EventThe Pivotal Event

•Recession

•Inflation

•Expectations change

•Wealth change

•Supply shocks

Table 45.1 Major Factors that Shift Curves in Each ModelRay and Anderson: Krugman’s Macroeconomics for AP, First Edition

Copyright © 2011 by Worth Publishers

The Initial Effect of the EventThe Initial Effect of the Event

•The effects of a curve shifting

Secondary and Long-Run EffectsSecondary and Long-Run Effects of the Event of the Event

•Secondary Effects

• Changes in the price level or real interest rate result in changes in some or all of the following:

• International Capital Flows

• Net Exports

• Investment

Secondary and Long-Run EffectsSecondary and Long-Run Effects of the Event of the Event

•Long-run Effects

• Government budget

• "Crowding Out"

• Capital formation

• Economic growth

Figure 45.1 (a) Analysis Starting PointsRay and Anderson: Krugman’s Macroeconomics for AP, First

EditionCopyright © 2011 by Worth Publishers

Figure 45.1 (b) Analysis Starting PointsRay and Anderson: Krugman’s Macroeconomics for AP, First

EditionCopyright © 2011 by Worth Publishers

Figure 45.1 (c) Analysis Starting PointsRay and Anderson: Krugman’s Macroeconomics for AP, First

EditionCopyright © 2011 by Worth Publishers

Unnumbered Figure 45.1Ray and Anderson: Krugman’s Macroeconomics for AP, First

EditionCopyright © 2011 by Worth Publishers

Unnumbered Figure 45.2Ray and Anderson: Krugman’s Macroeconomics for AP, First

EditionCopyright © 2011 by Worth Publishers

Unnumbered Figure 45.3Ray and Anderson: Krugman’s Macroeconomics for AP, First

EditionCopyright © 2011 by Worth Publishers

Unnumbered Figure 45.4Ray and Anderson: Krugman’s Macroeconomics for AP, First

EditionCopyright © 2011 by Worth Publishers