Final Review

CHAPTER TEN I. GDP- Gross Domestic Product A. Definition 1. GDP is the total market value of all final goods & services produced within a country in a given period of time. B. Calculating GDP 1. Spending Approach a) Consumption + Investment Spending + Government Purchase + Net Exports i. Consumption: C is total spending by households on goods & services, with the exception of purchases of new housing Goods include household spending on durable goods and non-durable goods Services include such intangible items ii. Investment Spending: I is total spending on goods (productive physical capital) that will be used in the future to produce more goods. Includes spending on: o Physical capital o Construction of structure o Changes to inventories iii. Government Purchases: G is all spending on the goods and services purchased by government at the federal, state, and local levels. Excludes transfer payments, such as SS or unemployment insurance benefits iv. Net Exports: Exports Imports Exports represent foreign spending on the economys goods and services Imports are the portions of C, I, and G that are spent on goods and services produced abroad. b) Whats in and whats out? i. Included: Domestically produced final goods and services, including capital goods, construction of structures, and changes to inventories ii. Not included: intermediate goods, inputs, used goods, financial assets like stock and bonds, foreign- produced goods and services (imports) 2. Income Approach a) Wages + Rent + Interest + Profit b) GDP measures total income of everyone in the economy C. Other Indicators 1. Disposable Income a) (Wages + profits + interest + rent) + Government Transfers Taxes b) Private Savings = DI Consumption D. What does GDP tell us? 1. Size of an economy 2. Economic growth 3. If there is a recession II. The Circular- Flow Diagram

A. Types of Market 1. Product Market: is a mechanism that allows people to easily buy and sell products. 2. Factor Market: refers to markets where services of the factors of production (not the actual factors of production) are bought and sold such as the labor markets, the capital market, the market for raw materials, and the market for management or entrepreneurial resources. 3. Financial Market: is a mechanism that allows people to buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices that reflect the efficient-market hypothesis. B. The total sum of flows of money into each sector must equal the total sum of flows of money coming out of that sector. 1. Households a) Flows into (income): wages, profit, interest, rent and government transfers b) Flows out (expenses): consumption, private savings, and taxes 2. Government a) Flows into: government borrowing, taxes b) Flows out: government purchases, government transfers 3. Firms a) Flows into: Borrowing, GDP b) Flows out: Investment, wages, profit, interest, rent 4. Foreign sector a) Flows into: Borrowing, imports b) Flows out: Lending, exports C. The total sum of flows of money into each market must equal the total sum of flows of money coming out of that market. 1. Product a) Flows into: Consumption, investment , government purchases, net exports b) Flows out: GDP 2. Factor a) Flows into: Wages, profit, interest, and rent b) Flows out: Wages, profit, interest, and rent 3. Financial a) Flows into: Foreign lending, private savings b) Flows out: Borrowing III. Real Versus Nominal GDP A. Nominal GDP 1. Values output using current prices a) It is not corrected for inflation b) Price x Quantity c) Measures Economic Growth: ((NGDPt-NGDPt-1)/(NGDPt-1))*100 B. Real GDP 1. Values output using the prices of a base year a) Is corrected for inflation b) Pricebase x Quantity c) Measures Economic Growth: ((RGDPt-RGDPt-1)/(RGDPt-1))*100

d) The change in RGDP is the amount that GDP would change if prices were constant e) RGDP per capita is the main indicator of the average persons standard of living IV. GDP Deflator and Inflation Rate A. Definition 1. Measures the price level by calculating the ratio of nominal to real GDP 2. Measure of the overall level of prices 3. Measures the current level of prices relative to the level of prices in the base year B. Formula 1. GDP deflatort= 100 x (NGDPt/RGDPt) C. Inflation Rate 1. Is the percentage change in some measure of the price level from one period to the next. 2. Using GDP deflator: INFt= ((GDP deflatort GDP deflatort-1)/(GDP deflatort-1)) * 100 V. GDP Does NOT Value: A. The quality of the environment B. The quality of life C. Non- market activity, such as the child care a parent provides his/her child at home D. An equitable distribution of income E. It is still the main indicator of a countrys economic well- being, even though it is not perfect

CHAPTER ELEVEN I. CPI A. Definition 1. The CPI is a measure of the overall cost of the goods and services bought by typical consumers. 2. The CPI is used to monitor changes in the cost of living over time. 3. The consumer price index, or CPI, measures the cost of the market basket of a typical urban American family. B. Difference between CPI and GDP Deflator 1. Included in GDP Deflator a) Capital goods if produced domestically 2. Included in CPI a) Imported consumer goods 3. The basket: a) CPI uses fixed basket b) GDP deflator uses basket of currently produced goods and services C. Calculating CPI 1. Fix the basket a) The Bureau of Labor Statistics (BLS) surveys consumers to determine whats in the typical consumers shopping basket. 2. Find the prices. a) The BLS collects data on the prices of all the goods in the basket. 3. Compute the baskets cost. a) Use the prices to compute the total cost of the basket at different times. 4. Choose a base year and compute the index: a) The CPI in any year equals: i. CPIt = ((Total cost of basket in yeart)/(Total cost of basket in base year)) x 100 5. Compute the inflation rate a) The percentage change in the CPI from the preceding period b) Inflation ratet = ((CPIt CPIt-1)/CPIt-1) x 100

CHAPTER TWELVE I. Economic Growth Around the World A. GDP per Capita 1. Is GDP divided by the size of the population 2. NGDP per capitat = (NGDPt/ Populationt) 3. RGDP per capitat = (RGDPt/ Populationt) a) It is more commonly used as a measure of standard of living than NGDP per capita is 4. Growth Rate of RGDP per capita = ((RGDP per capitat-RGDP per capitat-1)/(RGDP per capitat1))*100 a) Measures economic progress 5. Growth Rate of NGDP per capita= ((NGDP per capitat-NGDP per capitat-1)/(NGDP per capitat1))*100 II. Productivity 1. Labor Productivity 1. The amount of goods and services that a worker produces in a given amount of time 2. When a nations workers are very productive, RGDP is large and incomes are high 3. When productivity grows rapidly, so do living standards 4. RGDP/ # Employed 2. Four Important Factors of Labor Productivity 1. Physical Capital per Worker: The stock of equipment and structures used to produce goods and services is called [physical] capital, denoted K. a) K/L = capital per worker. b) Productivity is higher when the average worker has more capital (machines, equipment, etc.). c) Example: an increase in K/L causes an increase in Y/L. 2. Human Capital per Worker: the knowledge and skills workers acquire through education, training, and experience, denoted by H. a) H/L = the average workers human capital b) Productivity is higher when the average worker has more human capital (education, skills, etc) c) Example: an increase in H/L causes an increase in Y/L 3. Natural Resources per Worker: the inputs into production that nature provides, example: land, mineral deposits, denoted by N a) More N allows a country to produce more Y b) An increase in N/L causes an increase in Y/L c) Some countries are rich b/c they have abundant natural resources d) But countries do not need a lot of N to be rich 4. Technology Knowledge: societys understanding of the best ways to produce goods and services a) Doesnt mean a faster computer, HD TV, or a smaller cell phone b) It means any advance in knowledge that boosts productivity (allows society to get more output from its resources) III. Economic Growth and Public Policy A. Policies to Boost Productivity 1. Encourage saving and investment to raise K/L 2. Encourage investment from abroad to raise K/L 3. Provide public education to raise H/L

B.

C.

D.

E.

F.

G.

4. Patent laws or grants to increase Y/L 5. Control population growth to increase K/L Saving and Investment 1. Investment increases K 2. Since resources are scarce, producing more capital requires producing fewer consumption goods 3. Reducing consumption= increasing saving Investment from Abroad 1. To raise K/L and hence productivity, wages, and living standards, the govt can encourage: a) Foreign direct investment: a capital investment such as a factory that is owned and operated by a foreign entity b) Foreign portfolio investment: a capital investment financed with foreign money but operated by domestic residents 2. Some of the returns from these investments flow back to the foreign countries that supplied the funds. 3. Especially beneficial in poor countries that cannot generate enough saving to fund investment projects themselves 4. Also helps poor countries learn state- of- the- art technologies developed in other countries Education 1. Govt can increase productivity by promoting education- investment in human capital H a) Public schools, subsidized loans for college 2. Education has significant effects: in the U.S., each year of schooling raises a workers wage by 10% 3. But investing in H also involves a tradeoff b/w present and future: a) Spending a year in school requires sacrificing a years wages now to have higher wages later Health and Nutrition 1. Health care expenditure is a type of investment in human capital- healthier workers are more productive 2. In countries with significant malnourishment, raising workers caloric intake raises productivity Property Rights and Political Stability 1. The price system allocates resources to their most efficient uses 2. The requires respect for property rights, the ability of people to exercise authority over the resources they own 3. Economic stability, efficiency, and healthy growth require law enforcement, effective courts, a stable constitution, and honest govt official Research and Development 1. Technological progress is the main reason why living standards rise over the long run 2. One reason is that knowledge is a public good: Ideas can be shared freely, increasing the productivity of many 3. Policies to promote technology progress: a) Patent laws b) Tax incentives or direct support for private sector R&D c) Grants for basic research at universities

CHAPTER THIRTEEN I. Saving and Investment A. Savings = Investment Spending 1. Investment is the purchase of new capital 2. Closed Economy a) NX=0 b) I = GDP C G c) Private Savings = GDP + TR T C d) Public Savings = Govt Revenue Govt Spending e) Government Savings = T TR G f) National Savings = Private Savings + Public Savings = GDP C G g) So, in a closed Economy Investment Spending = National Savings 3. Open Economy a) I = (GDP C G) + ( IM X) b) I = ( Private Savings + Public Savings) + ( Net Capital Inflow) c) So, Investment Spending (I) = National Savings + KI B. Different Kinds of Saving 1. Private Saving: is the income remaining after households pay their taxes and pay for consumption 2. Public Saving or Government Saving is tax revenue less govt spending 3. National Saving is the portion of national income that is not used for consumption or govt purchases. a) National Savings + the sum of private savings + budget balance = Savings generated within the economy C. Matching Up Savings and Investment Spending 1. Budget balance: is the difference b/w tax revenue and govt spending 2. Budget surplus: is the difference b/w tax revenue and govt spending when tax revenue exceeds govt spending ( +) 3. Budget deficit: is the difference b/w tax revenue and govt spending when govt spending exceeds tax revenue (-) 4. Increase in budget deficit causes fall in investment a) Govt borrows to finance its deficit b) This is called crowding out c) Reduces the economys growth rate and future std. of living II. Market for Loanable Funds A. Loanable Funds Market 1. Hypothetical market that examines the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders 2. Loanable Funds: all income that people have chosen to save and lend out and to the amount that investors have chosen to borrow to fund new investment projects 3. Assume: a) There is only one financial market b) All savers deposit their savings in this market c) All borrowers take out loans from this market d) There is one interest rate, which is both the return to saving and the cost of borrowing B. Supply-Demand Model

1. Helps us understand how the financial system coordinates saving and investment and how govt policies and other factors affect saving, investment, the interest rate 2. Saving is the source of the supply of loanable funds a) Comes from: i. Households: with extra income can loan it out and earn interest ii. Firms: a firm can put its savings in the bank for future use iii. Government iv. Foreigners b) Factors that Shift the Supply Curve i. Changes in private savings behavior ii. Changes in the govt policies iii. Changes in capital inflows c) An increase (decrease) in the supply for loanable funds leads to a fall (rise) in the equilibrium interest rate d) Increase moves to the right; decrease moves to the left 3. Investment is the source of the demand for loanable funds a) Comes from: i. Firms: borrow the funds they need to pay for new equipment, factories, etc ii. Households: borrow the funds they need to purchase new houses iii. Government: to fund social security payments, to buy office supplies, to pay down its outstanding debts, to finance a deficit, to improve public sector b) Factors that Shift the Demand Curve i. Changes in perceived business opportunities ii. Changes in the govt policies c) An increase (decrease) in the demand for loanable funds leads to a rise (fall) in the equilibrium interest rate d) Increase moves to the right; decrease moves to the left

CHAPTER FIFTEEN I. Unemployment A. How is Unemployment Measured? 1. A monthly survey is conducted by the Bureau of Labor Statistics 2. Adult population = 16 years or older 3. Employed: the employed are individuals who currently have jobs 4. Unemployed: those who do not currently have a job but who are actively looking for work 5. Not in the Labor Force: retired people, and people who do not choose to work for whatever reason 6. Employment is the number of people currently employed in the economy, either full time or part time 7. Unemployment is the number of people who are actively looking for work but arent currently employed B. Unemployment Rate 1. Is the percentage of the total number of people in the labor force who are unemployed 2. = (# of Unemployed workers/ Labor force) x 100 3. Labor Force = # of Employed + # of Unemployed 4. Labor Force Participation Rate is the percentage of the population aged 16 or older that is in the labor force 5. = ( Labor Force/ Population age 16 and older) x 100 6. Population age 16 and older = # of Employed + # of Unemployed + # on Not in the Labor Force C. What Does U-Rate Measure? 1. Not perfect indicator of joblessness 2. Excludes discourage workers 3. Doesnt distinguish b/w full- time and part- time work, or people working part time b/c full time jobs not available D. 3 Types of Unemployment 1. Cyclical Unemployment: occurs during fluctuations in real GDP 2. Frictional Unemployment: occurs when workers spend time searching for the jobs that best suit their skills and tastes a) Short term for most workers b) The possible reason for this type is job search ( the process of matching workers with appropriate jobs) c) Examples: i. Workers who lost their jobs and are looking for new jobs. ii. Young workers who are seeking their first jobs. iii. Workers who had been out of the workforce for a while and had come back to work (reentrants). iv. Workers who are laid off due to high technology and looking for new jobs. 3. Structural Unemployment: occurs when there are fewer jobs than workers a) Usually longer- term b) 3 possible reasons: i. Minimum- wage laws: a govt mandated floor on the price of labor ii. Unions- a worker association that bargains with employers over wages, benefits, and working conditions

Unions exert their market power to negotiate higher wages for workers The typical union worker earns 20% higher wages and gets more benefits than a nonunion worker for the same type of work iii. Efficiency wages- wages that employers set above the equilibrium wage rate as an incentive for better performance Worker health Worker turnover Worker quality Worker effort E. Natural Rate of Unemployment 1. The unemployment rate that occurs in even a healthy economy 2. It is the unemployment rate that arises from the effects of frictional plus structural unemployment 3. Natural rate of unemployment = FU + SU 4. Actual Unemployment or U- rate = FU + SU + CU 5. CU rate = Actual Natural Rate 6. Full Employment: actual u- rate = natural rate of unemployment

CHAPTER SIXTEEN I. Money A. Meaning 1. Money is the set of assets in the economy that people regularly use to buy goods and services from each other. B. Functions 1. Medium of exchange: Any item that buyers give to sellers when they purchase goods and services. When we use money to buy groceries, money is playing the role of a medium of exchange. 2. Barter: The exchange of one good or service for another 3. Unit of account: A standard unit in which prices can be stated and the value of goods and services can be compared. When we put price on a meal, money is playing the role of a unit of account. 4. Store of value: The property of money that it preserves value until it is used in an exchange. When we keep money in a bank, money is playing the role of a store of value. C. Kinds of Money 1. Commodity money: It is money that takes the form of a commodity with intrinsic value. a) Examples: cattle, gold coins, cigarettes in POW camps 2. Fiat money: It is money without intrinsic value that is used as money because of government decree. a) Example: US dollar Money in the U.S. Economy A. Money Supply 1. The quantity of money available in the economy 2. Currency in circulation is cash held by the public. It is the paper bills and coins in the hands of the (non-bank) public. 3. Checkable bank deposits are bank accounts on which people can write checks. 4. Money market mutual funds allow you to write checks and make electronic transfers, but most accounts establish a minimum dollar amount. Electronic, telephone and pre-authorized transactions are limited by federal regulations to six per month, with no more than three being by check, draft or debit card. 5. A traveler's check is a preprinted, fixed amount check designed to allow the person signing it to make an unconditional payment to someone else as a result of having paid the issuer for that privilege. 6. Demand deposits or bank money are funds held in demand deposit accounts in commercial banks. (They are balances in bank accounts that depositors can access on demand by writing a check.) 7. M1= currency in circulation + travelers checks + bank deposits + other checkable deposits a) Most basic measure of money in the US is M1 8. M2= M1 + savings deposit + small time deposits + money market mutual funds + miscellaneous categories of M2 a) Broader measure of money commonly used and is used by economists to estimate the entire supply of money w/in an economy b) M2 is a key economic indicator used to forecast inflation 9. Whats not in the money supply: a) Financial assets like stocks and bonds

II.

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Federal Reserve System A. What is the Fed? 1. A central bank is an institution that oversees and regulates the banking system and controls the monetary base. 2. The Federal Reserve is a central bankan institution that oversees and regulates the banking system, and controls the monetary base. 3. The Fed was created in 1913 to provide central banking functions. 4. The Fed is a special institution that is neither exactly part of the government nor exactly a private institution. B. Responsibilities 1. The fed supplies currency to the economy. 2. The fed provides a system of check collection and clearing. 3. The fed holds reserves from banks and other depository institutions and regulates banks. 4. The fed conducts monetary policy a) Monetary policy- the range of actions taken by the Federal Reserve to influence the level of GDP or inflation 5. The fed makes loans to bankers when they want to borrow 3. The Feds Tools 1. Open- Market Operations: An open market operation is the purchase or sale of U.S. government securities by the Fed. 2. Reserve Requirements: (or Reserve Ratio) is a state bank regulation that sets the minimum reserves each Commercial bank must hold to customer deposits and notes a) Example: the amount that the bank surrenders with the central bank. (The minimum amount of reserves that banks must hold against deposits.) 3. Discount Rate: The discount rate is the rate of interest the Fed charges on loans to banks.

CHAPTER SEVENTEEN I. Velocity of Money A. Definition 1. The rate at which money turns over during the year ( the number of times a dollar changes hands during a given year in economic transaction) 2. Velocity Formula: V = NGDP/ M a) M = money supply B. Quantity Theory of Money 1. Quantity Equation a) M x V = P x Y b) It is the equation that links money, velocity, prices, and real output c) M = (P x Y)/ V d) Shows that an increase in the quantity of money must be reflected in one of the three variables e) If V is stable i. A change in M causes nominal GDP ( P x Y) to change by the same percentage ii. A change in M does not affect Y: Y is determined by technology and resources iii. P changes by the same percentage as P x Y and M iv. Rapid money supply growth causes rapid inflation II. Costs of Inflation and Deflation A. Hyperinflation 1. Hyperinflation is generally defined as inflation exceeding 50% per month 2. Excessive growth in the money supply always causes hyperinflation B. Costs of Inflation 1. Shoe- leather costs: are the increased costs of transactions caused by inflation 2. Menu cost is the real cost of changing a listed price 3. Unit- of- accounts cost: arise from the way inflation makes money a less reliable unit of measurement C. Costs of Deflation 1. Menu costs 2. Loss of govt revenues 3. Reduced employment and income 4. Decrease investment and consumption

CHAPTER TWENTY I. Business Cycle A. Business Cycle 1. Refers to economy- wide fluctuations in production or economic activity over several months or years 2. Recessions (contractions/busts): are periods of economic downturns when output and employment are falling 3. Expansions (recoveries/ booms): sometimes called recoveries, are periods of economic upturns when output and employment are rising 4. A depression is a very deep and prolonged downturn 5. The point at which the economy turns from expansion to recession is a business- cycle peak 6. The point at which the economy turns from recession to expansion is a business- cycle trough B. Three Facts About Economic Fluctuations 1. Fact 1: Economic fluctuations are irregular and unpredictable 2. Fact 2: Most macroeconomic quantities fluctuate together 3. Fact 3: As output falls, unemployment rises II. Short Run Economic Fluctuations A. Aggregate Demand Curve 1. Shows the relationship b/w the aggregate price level and the quantity of aggregate output demanded by households, businesses, the govt, and the rest of the world 2. Movement along the AD curve occurs when a change in the aggregate price level changes in the purchasing power of consumers existing wealth ( the real value of their assets) 3. Factors that shift the curve a) Change in expectation b) Change in consumer wealth c) Change in fiscal policy d) Change in monetary policy e) Change in the foreign income 4. Components of AD: consumption, investment spending, govt transfers, net exports a) Changes in C: Stock market boom/crash, tax hikes/cuts, Monetary policy b) Changes in I: expectations, optimism/pessimism, monetary policy c) Changes in G: Federal spending, state and local spending d) Changes in NX: booms/ recessions in countries that buy our exports 5. Positive Demand Shock: AD shifts to the right 6. Negative Demand Shock: AD shifts to the left B. Aggregate Supply Curve 1. Shows the relationship b/w the aggregate price level and the quantity of aggregate output in the economy 2. Shows the relationship b/w the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed 3. Movement down the SRAS curve leads to deflation and lower aggregate output 4. Factors that shift the curve a) Changes in commodity prices i. Oil is a commodity

III.

b) Changes in nominal wages i. At any given point in time, the dollar wages of many workers are fixed b/c they are set by contracts or informal agreements made in the past. But nominal wages can change once enough time has passed for contracts or informal agreements to be renegotiated c) Changes in labor productivity i. An increase in productivity means that a worker can produce more units of output with same quantity of inputs 5. Positive Supply Shock: SRAS shifts to the right 6. Negative Supply Shock: SRAS shifts to the left C. Short- Run Macroeconomic Equilibrium 1. The economy is in short-run macroeconomic equilibrium when the quantity of aggregate output supplied is equal to the quantity demanded. 2. The short-run equilibrium aggregate price level is the aggregate price level in the short-run macroeconomic equilibrium. 3. Short-run equilibrium aggregate output is the quantity of aggregate output produced in the short-run macroeconomic equilibrium D. Long- Run Aggregate Supply Curve 1. Shows the relationship b/w the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages were flexible 2. A vertical aggregate supply curve that represents the idea that in the long run, output is determined solely by the factors of production 3. Yp is potential output (full- employment output or natural rate of output) a) Provides a bench mark for identifying phases of the business cycle and as a guide for stabilization policies 4. Long-Run Macroeconomic Equilibrium: when the point of short- run macroeconomic equilibrium is on the long- run aggregate supply curve Self- Correcting Model A. Milton Friedman 1. In a self-correcting model, problems such as unemployment are resolved without govt intervention, through the working of the invisible hand 2. According to the Keynesian economics, economic slumps are caused by inadequate spending and they can be mitigated by govt intervention B. Recessionary and Inflationary Gap 1. Recessionary Gap a) Occurs when the economy is in a recession b) Is the amount by which the RGDP is below potential GDP c) There are more workers than jobs d) Nominal wages go down e) U-rate goes up f) Cost of production goes down g) Profit per unit rises h) Occurs in Negative Demand/ Supply Shock i) Stagflation occurs when the economy isnt growing but prices still rise 2. Inflationary Gap a) Occurs when the economy is in a boom

b) Is the amount by which the RGDP exceeds potential GDP c) There are more jobs than workers d) Nominal wages go up e) U- rate goes down f) Cost of production goes up g) Profit per unit goes down h) Occurs in Positive Demand/Supply Shock C. In- Class Activity 20: 3

CHAPTER TWENTY- ONE I. John Maynard Keynes A. Stabilization Policy 1. They are policy actions taken to move the economy closer to full employment or potential output 2. Two ways: a) Fiscal b) Monetary Fiscal Policy and the AD Curve A. Definition 1. Fiscal policy is the use of taxes, govt transfers, or govt purchases of goods and services to shift the aggregate demand curve to stabilize the economy 2. In practice, govt often respond to recessions by increasing govt spending, cutting taxes, or both 3. The govt often responds to inflation by reducing govt spending or increasing taxes B. Expansionary Fiscal Policy 1. AD curve shifts to the right 2. Increases aggregate demand to improve economic performance 3. Government Spending is INCREASED 4. Transfers are INCREASED a) Disposable Income is increased b) Consumption to increase 5. Taxes are DECREASED a) Disposable income increases b) Consumption increases 6. Used to close Recessionary Gap 7. Negative Demand/ Supply Shock C. Contractionary Fiscal Policy 1. AD curve shifts to the left 2. Reduces aggregate demand to get rid of the economic fluctuations 3. Government Spending is DECREASED 4. Transfers are DECREASED a) Disposable Income decreases b) Consumption to decrease 5. Taxes are INCREASED a) Disposable Income increases b) Consumption increases 6. Used to close Inflationary Gap 7. Positive Demand/ Supply Shock D. In Class Activity 21: 1 Monetary Policy and the AD Curve A. Demand for Money 1. To facilitate transactions, since money is the medium of exchange 2. As a precautionary store of liquidity, in the event of unexpected need 3. To reduce the riskiness of a portfolio of assets by including some money in the portfolio, since the value of money is very stable compared with that of stocks, bonds, or real estate

II.

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C.

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4. MD curve shows the relationship b/w the quantity of money demanded and the interest rate Definition of Monetary Policy 1. The process by which the govt, central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy 2. Three tools: a) Open Market Operations: the purchase or sale of US govt securities by the Fed b) Reserve Requirements: is a state bank regulation that sets the minimum reserves each Commercial bank must hold to customer deposits and notes i. the amount that the bank surrenders with the central bank ii. rarely used to control money supply c) Discount Rate: the rate interest the Fed charges on loans to banks Expansionary Monetary Policy 1. Increases the total supply of money in the economy 2. Used to combat unemployment in a recession by lowering interest rates 3. Increases AD, so curve shifts to the right 4. Buying Bonds 5. Lowering Reserve Requirement 6. Lowering Discount Rate 7. Money supply increase 8. Interest rate decreases 9. Investment spending and consumption increases 10. Reduces the interest rate by increasing the money supply....increases I and C, which in turn increases AD and RGDP in the short run 11. Used to close recessionary gap Contractionary Monetary Policy 1. Decreases the total money supply 2. Involves raising interest rates in order to combat inflation 3. Decreases AD, so curve shifts to the right 4. Selling Bonds 5. Increasing Reserve Requirements 6. Raising Discount Rate 7. Money supply decreases 8. Interest rate increases 9. Investment spending and consumption decreases 10. Raises interest rate by reducing money supply....reduces I and C, which in turn reduces AD and RGDP in the short run 11. Used to close inflationary gap Money Supply 1. The supply of money is the quantity of money, currency, and bank deposits, set by the Fed. 2. Supply curve shows how the nominal quantity of money supplied varies with interest rate 3. Increase in supply of money, curve shifts to the right 4. Decrease in supply of money, curve shifts to the left 5. Expansionary Monetary Policy: MS curve shifts to the right as well as the AD curve 6. Contractionary Monetary Policy: MS curve shifts to the left s well as the AD curve

7. Liquidity Preference Model: the interest rate is determined by the supply and demand for money F. In Class Activity 21:2 & 3