The difference between a change in demand and a
change in quantity demanded
P
Qo
$5
4
3
2
1
P QD
$54321
1020355580
D
Price of Corn
Quantity of Corn
CORN
10 20 30 40 50 60 70 80
What if
Demand
Increases?
GRAPHING DEMAND
P
Qo
$5
4
3
2
1
P QD
$54321
D
Price of Corn
Quantity of Corn
CORN
10 20 30 40 50 60 70 80
D’
Increase
in
Demand
Increase
in Quantity
Demanded1020355580
30406080 +
GRAPHING DEMAND
The difference between a change in supply and a
change in quantity demanded
SP
Qo
$5
4
3
2
1
10 20 30 40 50 60 70 80
$54321
60503520 5
P QS
Price of Corn
Quantity of Corn
CORN
What if
Supply
Increases?
GRAPHING SUPPLY
SP
Qo
$5
4
3
2
1
10 20 30 40 50 60 70 80
Price of Corn
Quantity of Corn
$54321
60503520 5
P QS
CORN
8070604530
S’Increase
in
Supply
Increase
in Quantity
Supplied
GRAPHING SUPPLY
Mislabeling or NOT labeling graphs correctly
Pric
e Le
vel
Real Domestic Output, GDP
Q
P AS
AD
Y
EQUILIBRIUM AND CHANGESIN EQUILIBRIUM
P
EquilibriumReal Output
LRAS
GROWTH IN THE AD-AS MODEL
A
B
C
D
Ca
pit
al G
oo
ds
Consumer Goods
Pri
ce
Lev
el
Real GDP
ASLR1 ASLR2
Q1 Q2
No
min
al I
nte
res
t R
ate
Amount of money demanded(billions of dollars)
0 50 100 150 200 250 300
10
7.5
5
2.5
0
Dm
ie
Sm Use this graph when the FED changes the money supply to change interest rates.
Sm1
THE MONEY MARKET
Net effects of Monetary Policy and/or Fiscal
Policy onInterest Rate
Expansionary Fiscal Policy = Interest Rate INCREASE
• Exp. Fiscal Policy (Gov’t deficit) Increase Demand for Money Increase Interest Rate.
• Higher Price Level Increase Demand for Money Increase Interest Rate.
Expansionary Monetary Policy Interest Rate DECREASE
Real domestic output, GDP
Dm
InvestmentDemand
Nom
inal
inte
rest
rat
e
10
8
6
0Quantity of money Amount of investment, I
MONETARY POLICY AND EQUILIBRIUM GDPSm1
AS
AD1P1
10
8
6
0
Sm2
AD2
P2
Money Supply Increases
Interest Rate Decreases
Investment Increases
AD & GDP Increaseswith slight inflation
If the moneysupply increasesto stimulate the
economy...
Pri
ce le
vel
AD3
Pri
ce le
vel
Real domestic output, GDP
Dm
InvestmentDemand
Rea
l rat
e of
inte
rest
, i
10
8
6
0Quantity of money demanded and supplied Amount of investment, i
MONETARY POLICY AND EQUILIBRIUM GDPSm1
AS
AD1P1
10
8
6
0
Sm2
AD2
P2
More Money Supply
Lower Interest Rates
More Investment
Still higher AD & GDPwith significant inflation
Sm3
P3 If the moneysupply increases
again…
MULTIPLIER(S) CONFUSION
Change inGDP = Multiplier x initial change
in spending
Multiplier = or 1
MPS
1
1 - MPC
THE MULTIPLIER EFFECT
.9
.8
.75
.67
.5
10
5
4
3
2
MPC Multiplier
MPC and the Multiplier
MONEY MULTIPLIER
• 1 / Required Reserve Ratio
• Maximum Multiple $$$ Money Expansion
MULTIPLE DEPOSIT EXPANSION PROCESS
BankAcquired reserves
and depositsRequiredreserves
Excessreserves
Amount bankcan lend - Newmoney created
ABCDEFGHIJKLMNOther banks
$100.00 80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 21.97
$20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40
$80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57
$80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57
$400.00Total amount of money created by the banking system
Balanced Budget Multiplier= 1
(Net Result on GDP)
New reserves$800
ExcessReserves
$4000Bank System Lending
FEDERAL RESERVE PURCHASE OF BONDS FROM PUBLIC
Purchase of a$1000 bondfrom public...
$200Requiredreserves
$1000Initial
Deposit
Total Increase in Money Supply ($5000)
New reserves$800
ExcessReserves
$4000Bank System Lending
Someone deposits $1000 in newReserves at a bank.
$200Requiredreserves
$1000Initial
Deposit
Total Increase in Money Supply ($4000)
New reserves$1,000Excess
Reserves
$5,000PMC thru Bank Lending
Fed Buys A $1,000 Bond From Joe’s Bank
TMS is $5000
20% RR
$20Requiredreserves
$100New reserves
$100Initial
Deposit
$400Bank system lending
Money Created
$80Excess
reserves
OUTCOME OF MONEY EXPANSION
Leakages exist...
(Savings) Currency Drains Excess Reserves
$20Requiredreserves
$100New reserves
$100Initial
Deposit
$400Bank system lending
Money Created
$80Excess
reserves
Injections: Additional Spending into
Income – Expenditures stream: Investment,
G, or Xn
UNEMPLOYMENTTypes of Unemployment
Frictional UnemploymentStructural UnemploymentCyclical Unemployment
Natural rate of Unemployment = Structural + Frictional (Around 4-5%)
real
in
tere
st r
ate
Quantity of Loanable Funds
LOANABLE FUNDS MARKET
r
D
Q
S
This graph shows how the supply and demand for loanable funds affects real interest rates
Loanable Funds Market Graph(Long-Term Interest Rates)
What changes Supply:
1. Increase in Household savings
2. Increase in Gov’t savings
3. Increase in Business savings
4. Increase in Business savings
5. Increase in Foreigners’ savings
What changes Demand: 1. Increase in Household
borrowing2. Increase in business
Investment3. Increase in Foreign
borrowing4. Increase in Government
borrowing (When the gov’t has a budget deficit!) = (the crowding -out effect)
Price Index
Price Index Price of market basket in specific yearin a given = --------------------------------------------- X 100 Year Price of same market basket in base year
Nominal GDPReal GDP = ------------------------------- X 100
Price Index
Remembering the difference between
Real and
Nominal
Nominal:with Inflation
Real:Adjusted for Inflation
NominalInterest
Rate
RealInterest
Rate
InflationPremium
=11%
5%
6%+
Nominal vs. Real
NominalInterest
Rate
RealInterest
Rate
InflationPremium
-
16%10%
6%
Real Interest Rate[Nominal I.R. – inflation rate = Real I.R.]
=
Demand-Pull Inflation
vs.
Cost-Push Inflation
DEMAND-PULL INFLATION
o
P1
AS1
ASLR
AD1
a
Q1
Pri
ce L
evel
Real domestic output
bP2
P3
AD2
AS2
c
Q2
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Q1
Pri
ce L
evel
Real domestic output
bP2
AS2
Occurs when short-run AS shifts left
Q2
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Q1
Pri
ce L
evel
Real domestic output
bP2
P3
AD2
AS2
Government response with increased AD
c
Evenhigherpricelevels
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Q1
Pri
ce L
evel
Real domestic output
bP2
AS2
Q2
Q2
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Q1
Pri
ce L
evel
Real domestic output
bP2
AS2
If government allows a recession to occur
Nominal wages fall (which
increases AS &AS returns
to its originallocation
People must believe Fed is serious about stopping inflation. Higher expectations decreases Aggregate Supply.
An
nu
al r
ate
of in
flat
ion
(per
cen
t)
Unemployment rate (percent)
7
6
5
4
3
2
1
01 2 3 4 5 6 7
As inflation declines...
THE PHILLIPS CURVE CONCEPT
Unemploymentincreases
An
nu
al r
ate
of in
flat
ion
(per
cen
t)
Unemployment rate (percent)
7
6
5
4
3
2
1
01 2 3 4 5 6 7
THE PHILLIPS CURVE CONCEPT
LRPC = Natural Rate of Unemployment
GENERAL EXAM ADVICE
Free Response: • Do not restate question• Use correct terminology• Even if a graph is not required, draw
one anyway and explain. • Use same outline as question• Use Good Handwriting
GENERAL EXAM ADVICE
• Draw graphs large enough for the reader to tell what’s going on.
• Explain your reasoning: “the price increased”, why?
• No Calculators
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