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NYU / Engineering / ECON 1 / What are the ten principles of economics?

What are the ten principles of economics?

What are the ten principles of economics?

Description

School: New York University
Department: Engineering
Course: Intro to Macroeconomics
Professor: Gerald mcintyre
Term: Fall 2016
Tags: Economics, Econ, and Macroeconomics
Cost: 50
Name: Macroeconomics Fall 2016 Study Guide
Description: Hello all! This study guide summarizes all the chapters we have gone over..it is color coded and there is a key included in the top. Class lectures, Aplia and problem sets are incorporated. I hope this helps and good luck on the exam!!
Uploaded: 12/13/2016
19 Pages 27 Views 27 Unlocks
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December 6th, 2016  


What are the ten principles of economics?



Macro Fall 2016 Final Study Guide  

Key:  

P=Price  

D=demand  

S=supply  

QD=quantity demanded  

QS=quantity supplied  

SR=short run  

LR=long run  

AD=aggregate demand  

AS=aggregate supply  

NOTE:  

 the underlined terms are concepts you should familiarize yourself with   the terms in red are more like definitions that you should study   equations/formulas are highlighted in purple  

—macroeconomics  

 -the study of forces and trends that affect the economy as a whole  —ceteris assumption  


How individual people make decisions?



 -if P goes up, QD goes down (inverse relationship)  

—quantity demanded vs demand  

 -QD is a point on a given D curve  

 -D refers to the entire curve  

 

SUMMARYS  

Chapter 1: Ten Principles of Economics  

 —How Individual People Make Decisions 

 -people face trade-offs: there are costs in being in class or going to a concert   -the cost of any action is opportunity cost (what you give up to get it) and this  cost varies on the person  If you want to learn more check out What is the total fertility rates in the usa?

 -rational people make decisions at the margin (they compare marginal costs and  marginal benefits): if you sunk some money into a project, that money is gone and you think  about the extra benefit you’ll get from doing this activity  


What is supply curve?



If you want to learn more check out What is sharecropping in us history?

 -*people respond to incentive*: the best four-word definition of all of economics   —How People Interact 

 -trade and interdependence can make everyone better off   -markets are the way to go when organizing economic

 -the government can improve market outcomes (like trying to fix a market failure  or promoting greater economic equality)  

 —The Economy as a Whole  

 -productivity is the ultimate source/indicator of a society’s/country’s living  standards: (Y/L)xL  

 -growth in amount of money in circulation is the source of inflation; when the  government prints too much money prices rise  

 -society faces a SR trade-off between inflation and unemployment    

Chapter 2: Thinking like an Economist  

 —Two Simplified Models  Don't forget about the age old question of What is ecology?

 -circular flow diagram  

 -production possibilites frontier  

 —positive statement  

 -an assertion/statement about how the world IS  

 —normative statement  

 -how the world ought to be  

 -when these types of statements are made, economists act more like policy  advisers than they do scientists  

 —not all economists agree on every issue/policy  

 -there are differences in scientific judgments/values  

Chapter 3: Interdependence and the Gains from Trade  

 —interdependence and trade are desirable because allow everyone to enjoy a greater  quantity and variety of goods and services  

 —absolute advantage  

 -the person who can produce the good/service with the smallest quantity of  inputs  

 —comparative advantage  

 -the ability to produce a good at a lower opportunity cost than another producer   —trade makes everyone better off because it allows people to specialize in the  activities in which they have the comparative advantage  

 —comparative advantages applies to countries as well as people  

Chapter 4: The Market Forces of Supply and Demand  

 —competitive markets  

 -use to the model of supply and demand to help analyze it   -there are many buyers and sellers  If you want to learn more check out What are the characteristics of atoms?

 -each of these buyers and sellers has little to no influence on market prices   —demand curve  

 -shows us how the Q of a good demanded depends on the P   —Law of Demand

 -as the price of a good falls, the QD rises  

 -an inverse relationship  

 -slopes downward  

 —determinants that shift the demand curve  

 -income (more income, more demand of normal goods)  

 -the price of substitutes and complements  

 -tastes  

 -expectations (if buyers expect prices to go up in the future, they will demand  more now)  

 -the number of buyers  

 —supply curve  

 -shows how the quantity of a good supplied depends on the price   —Law of Supply  

 -as the P of a good rises, the Q supplied rises  

 -the curve slope upward  

 —determinants that shift the supply curve  

 -input prices  

 -technology  

 -expectations  

 -number of sellers  

 —when the P is above the equilibrium, surplus and the market price falls   —when the P is below the equilibrium, shortage and the market price rises   —in market economies, prices are the signals that guide economic decisions  If you want to learn more check out What is the relative refractory period?

CHAPTERS 5-9 NOT IN THE EXAM  

Chapter 10: Measuring a Nation’s Income  

 —evert transaction has a buyer and seller  

 —GDP  

 -measures an economy’s total expenditure on NEWLY produced goods and  services and total income/money generated from the production of these goods and services   -the market value of all FINAL good and services produced with a country in a  given period of time  

 -a good measure of economic well-being because people prefer higher to lower  incomes  

 —GDP Components  We also discuss several other topics like Who is genghis khan?

 -consumption (C): spending on goods and services by households (but does not  include new housing)  

 -investment (I): spending on new equipment and structures (this is where new  housing falls under)  

 -government purchases (G): spending on goods and services by local, state and  federal governments

 -net exports (NX): the value of goods and services produced in the country and  sold abroad (exports) minus the value of goods and services that are produced elsewhere and  brought into the country (imports)  

 —nominal GDP (NGDP)  

 -uses current prices to value the economy’s level of production of goods and  services  

 —real GDP (RGDP)  

 -uses base-year prices to value the economy’s production of goods and services   —GDP deflator  

 -measures the levels of prices in the economy  

 —GDP doesn’t measure everything  

 -GDP excludes the value of leisure and value of a clean environment   -also does not include mental and emotional well being  

NGDP, RGDP and GDP Deflator example… 

 

 —computing the annual NGDP:  

 -uses current prices and current quantities  

 -start with year 2011  

 formula: 2011—>10(100)+5(200)=2,000  

 2012—>11(100)+6(250)=2,600  

 2013—>12(150)+7(250)=3,550  

 —computing RGDP for each year using 2011 as the base year  

 -always going to use the base year prices but current quantities   formula: 2011—>10(100)+5(200)=2,000  

 2012—>10(100)+5(250)=2,250  

 2013—>10(150)+5(250)=2,750  

 —computing the GDP deflator for each year:  

 -formula: (NGDP/RGDP)X100

 2011:(2,000/2,000)X100=100 (this is base year and should always be 100)   2012: (2,600/2,250)X100=115.6  

 2013:(3,550/2,750)X100=129.1

Chapter 11: Measuring the Cost of Living  

 —Consumer Price Index (CPI)

 -used to measure the overall level of prices in the economy   -shows us the cost of a basket of goods and services relative to the cost of the  same basket in the base year  

 -the % change in the CPI measures the inflation rate  

 —the CPI is an imperfect measurement for the cost of living  

 -does not take into account the consumers’ ability to substitute goods that are  cheaper  

 -it doesn’t taken purchasing power into account and how it can increase over  time  

 -it does not measure the quality of goods and services  

 -it overstates true inflation  

 —GDP deflator  

 -measures the overall level of prices in the economy (like the CPI)   -unlike CPI, it includes goods and services PRODUCED rather than goods and  services CONSUMED  

 -automatically changes the group of goods and services over time as the GDP  changes  

 —you cannot compare the purchasing power of the dollar from the past to the dollar  figure now; you have to inflate it using the price index  

 —it’s important to correct for inflation who looking at data on interest rates   -the nominal interest rate is the one that’s usually reported (the rate that your  money grows over time in a savings account)  

 -the real interest rate takes the into account the changes in the value of the  dollar over time  

 -real interest rate equals the nominal interest rate when we take away the rate of  inflation  

Calculating CPI, GDP Deflator to Determine Inflation example…  

 —calculate CPI using 2012 as a base year with a fixed basket at 2 books and 4  pizzas(setting the basket is the first thing and it will generally be given to you)

 -calculate the cost of this fixed basket in each year using the price given   -cost of basket for 2012: 15(2)+5(4)=50  

 2013: 18(2)+7(4)=64  

 -CPI: 2012: (50/50)X100=100  

 2013: (64/50)X100=128  

 -the last thing we want to do is compute the percent change in the overall price  level  

 -take the index in 2013 (128) and subtract from previous year (100) and divide by  100  

 -(128-100)/100=28%  

 —using the GDP deflator to calculate the % change in the overall price level using 2012  as the base year  

 -we need to calculate NGDP and RGDP  

 -NGDP: take the P of the good times the Q of the good of each of the goods   2012:15(200)+5(400)=5000  

 2013:18(250)+7(450)=7650  

 -RGDP: set the price at the base year price (book @ $15 and pizza @ $5 and  hold these prices constant for each year)  

 2012: 15(200)+5(400)=5000  

 2013: 15(250)+5(450)=6,000  

 -the last step is to take values calculate from NGDP and divide the by  calculations for RGDP and multiple those ratios by 100 to get an index number   -GDP deflator for 2012 (you take calculation from 2012 NGDP and divide by  calculation for 2012 RGDP)  

 (5000/5000)X100=100  

 -GDP deflator for 2013 (you take the calculation from 2013 NGDP and divide by  calculation for 2013 RGDP)  

 (7600/6000)X100=127.5  

 -percent change in price level  

 (127.5-100)/100=27.5%  

Chapter 12: Production and Growth  

 —economic prosperity (measures by GDP per person) varies around the world   —the average income in the world’s richest countries is more than ten times that in the  world’s poorest countries  

 —growth rates of RGDP vary substantially  

 —standard of living  

 -depends on the economy’s ability to produce goods and services   —productivity  

 -depends on physical capital, human capital, natural resources and technological  knowledge  

 —how the government can influence economy’s growth and increase standard of living   -encouraging saving and investing

 -encouraging investment from abroad  

 -focusing on education  

 -promoting good health  

 -maintaining property rights  

 -free trade  

 -promoting the research and development of new technologies   —diminishing returns  

 -the more capital an economy has, the less additional output the economy gets  from an extra unit of capital  

 -growth eventually slows down as capital, productivity and income rise   -richer countries have higher diminishing returns than poor countries   -poor countries can grow faster because of the catch-up effect   —population growth  

 -rapid population growth leads to lower productivity because the supply of  resources gets more spread out and reduces the amount of capital available for each worker   -can enhance the rate of technological progress because there are more  scientists and engineers  

 —most economists are not concerned that natural resources will eventually limit  economic growth  

 -prices of most natural resources(adjusted for inflation) have tended to fall over  time  

Real GDP per Person, Growth Rate and the Catch-Up Effect 

 —country A is the richest even though it only has a growth rate of 1.7%   -rather than focusing on growth rate, we focus on RGDP per person (because  diminishing returns)  

 -country A has the highest RGDP per person  

 —country B is advancing most quickly @ 2.9%  

 -we focus on the growth rate because it tells us how fast the economy is growing   —country C would see the greatest benefit from an increase in capital investment   -we have to think about the catch-up effect to understand the reasoning for it   -country C is relatively poor and there is little capital per worker

Chapter 13: Saving, Investment and the Financial System  

 —financial institutions: act to direct the resources of households that want to save some  of their income  

 -bond market  

 -stock market  

 -banks  

 -mutual funds  

 —in a closed economy, national saving must equal investment  

 -the economy matches one person’s saving with another person’s investment   —the supply and demand for loanable funds  

 -the supply of loanable funds comes from households that want to save some oft  their income and lend it out  

 -the demand for loanable funds comes from households and firms that want to  borrow for investment  

 -this is how the interest rate is determined  

 —national saving  

 -national saving=private saving plus public saving  

 -government budget deficits reduce national saving and the supply of loanable  funds available  

 -when the deficit crowds out investment, it reduces the growth of productivity  and GDP  

Calculating Private Saving, Public Saving, National Saving, Investment, and the Equilibrium Real Interest Rate  

 

—general equation for saving: S=(Y-T-C)+(T-G)

 -y income, t taxes, c consumption, g government expenditures   =(25,000-2,000-8,000)+(2,000-2,500)   =15,000+(-500)  

 ^private ^public  

 -add them together for national saving  

 S=14,500  

—calculating investment  

 -S=I  

 -I=14,500

—calculating the equilibrium real interest rate:  

 -now that we know what I is equal to, we can solve for R using the formula to get  I stated above  

 14,500=15,100-200r  

 200r=600  

 r=3%  

 —Side Notes 

 -short-term bonds are less risk than long-term bonds and so a bond that matures  in tend years will like have a lower interest rate than a bond that will mature in 30 years   -selling bonds to raise money is known as debt finance  

 -buying a bond is like buying a promise to pay from the company   -debt finance: the sale of bonds to raise funds  

 -equity finance: the sale of stock  

 

Chapter 14: NOT IN THE EXAM  

Chapter 15: Unemployment  

 —the unemployment rate  

 -the percentage of those who would like to work but do not have a job   -the BLS calculates this on a monthly basis by surveying thousands of  households  

 -it is an imperfect measurement when trying to calculating the number of people  without jobs; some people say they’re unemployed but simply actually don’t want to work why  some would like to work but have left the labor force because they didn’t find anything (and  they are not counted as unemployed)  

 -in the US economy most people who are unemployed find work within a short  period of time  

 —our economy ALWAYS has unemployment  

 -it takes time for workers to search for jobs that best suits their tastes and skills   -minimum-wage laws raise the Q of labor supplied and reduce the Q demanded  and so there is a surplus of labor  

 -when unions push wages above the equilibrium level, they create a surplus of  labor

 -theory of efficiency wages: firms find it profitable to pay wages above the  equilibrium (and yet again a surplus of labor)  

 —types of employment/Unemployment

 -frictional unemployment: in between jobs, those entering the work force, short term/little hardship involved  

 -seasonal unemployment: industries hire you but certain months are “off  season” (like at ski resorts), short term and predictable  

 -structural unemployment: mismatch between jobs and needs/worker and  employer locations  

 -cyclical unemployment: arises from changes in production over the business  cycle  

 

UNEMPLOYMENT RATE WILL NEVER BE 0%  

5% unemployed is called full employment (because we can’t help the remaining 5%), the 5% is  not cyclical  

****in 08, 10% was the unemployment (but 5% is normal), so the cyclical unemployment rate is  actually 5%****  

Calculating the Size of the Labor Force, the Unemployment Rate and the Labor-Force Participation Rate  

 

 —calculating labor force for males:  

 -labor force (LF)=Employed+Unemployed   =77.6+6.4  

 =84 million  

 -calculating those not in labor force (males)   look at population: Pop=LF+ Not in LF   not in LF=Pop-LF

 =118-84  

 =34.6 million  

 —calculating the unemployment rate (UR) for males  

 UR=(unemployed/LF)X100

 =(6.4/84)X100  

 =7.6%  

 —calculate the LF participation rate (LFPR) for males  

 LFPR=(LF/Pop)X100  

 =(84/118.6)X100  

 =70.8%  

 —calculating labor force for females  

 LF=67.5+5.7  

 =73.2 million  

 calculating those not in labor force  

 look at population: 127.2-73.2  

 =54 million  

 

 —calculating the UR for females  

 =(5.7/73.2)X100  

 =7.8%  

 —calculating LFPR  

 =(73.2/127.2)X100  

 =57.5%  

 —calculating COMBINED values (you just add the values from the two groups up)   employed : 145.1 million  

 unemployed: 12.1 million  

 adult population: 245.8 million  

 

 LF=145.1+12.1=157.2 million  

 not in LR=245.8-157.2  

 =88.6 million individuals  

 UR=(12.1/157.2)X100=7.7%  

 LFPR=(157.2/245.8)X100=64%  

Chapter 16: The Monetary System  

 —money

 -the assets that people regularly use to buy goods and services   —the three functions of money  

 -serves as a medium of exchange (it’s used to make transactions)   -a unit of account (it provides the way in which prices and other economic values  are recorded)  

 -a store of value (it offers a way to transfer purchasing power from the current  time to a time in the future)

 —intrinsic vs not having intrinsic value  

 —the Federal Reserve  

 -the central bank of the United States  

 -responsible for regulating the US monetary system  

 -the Fed chairman (appointed every 4 years) is the head of the Federal Open  Market Committee  

 -it controls the money supply through Open Market operations   —Bank Depositors  

 -provide resources to banks by depositing their funds (money into the bank)   —bank owners

 -provide resources (bank capital) for the bank  

 —leverage; the use of borrowed funds for investment  

 —open-market operations 

 -how the Fed controls the money supply  

 -purchasing government bonds increases the money supply   -sale of government bonds decreases the money supply   -expanding the money supply by decreasing the discount rate, decreasing  lending to banks, raising reserve requirements or increasing the interest rate on reserves   —contracting the money supply by doing the opposite  

Calculating the Money Multiplier and Money Supply in a Fractional-Reserve Banking System    

 —calculating the money multiplier (MM)  

 -can be derived from looking at the reserve ratio (R): in this case it’s 20%   R=20%=1/5  

 -the money multiplier is the reciprocal of the reserve ratio=1/R   the MM is 5  

 —calculating the money supply  

 -use the MM and multiple by the amount of reserves  

 Money Supply=Multiplier x Reserves  

 =(5)(500)  

 =2,500 billion  

 —if Fed reduces the required reserves to 10% of deposits…

 -calculate the new MM  

 R=10%=1/10  

 MM=10  

 -it is important to not that reserves are going to STAY THE SAME (still 500)   10(500)=5000 (billion) is the new money supply  

 —Notes:  

 -if a bank decides to add $100 to reserves, the money supply is unchanged; but  if the bank decides to lend out part of that $100, then the money supply increases  

NOTE: familiarize yourself with leverage ratio and how to calculate capital if assets are  increased or reduced  

Chapter 17: Money, Growth and Inflation  

 

 —prices adjust to bring money supply and money demand into balance   —when the central bank increases the supply of money, it causes the price level to rise   —monetary neutrality  

 -changes in the quantity of money influence nominal variables BUT NOT real  variables  

 -most believe that it describes the behavior of the economy in the long run   —the Fisher effect

 -an application of monetary neutrality  

 -when the inflation rate rises, the nominal rate rises by the same amount so that  the real interest rate remains the same  

 —hyperinflation  

 -when countries rely heavily on printing money in order to pay for some of its  spending  

 -is also known as the “inflation tax”  

 —shoe-leather costs: the resources that are wasted when inflation encourage people to  reduce the money that they possess  

 —menu costs: the costs of changing prices  

 —the six costs of inflation  

 -shoe-leather costs are associated with reduced money holdings   -menu costs are associated with more frequent adjustment of prices   -increased variance of relative prices  

 -unexpected changes in tax liabilities  

 -confusions and inconvenient stemming from a changing unit of account   -redistributions of wealth between debtors and creditors  

Calculating the  

Before-Tax and After-Tax Real Interest Rate

   

—@ nominal interest rate of 8% and inflation at 3%  

 Before: Real=Nominal interest rate-Inflation Rate

 =8%-3%  

 =5%  

 After: Real=Nominal interest rate(with tax rate factored in)-Inflation rate   -it is important to keep in mind that the investor in not going to keep  100% of nominal interest earned; the investor is only going to keep 70% because 30% goes to  taxes  

 Real=.70(Nominal)-Inflation  

 =.70(8%)-3%  

 =2.6%  

 —@ nominal interest rate of 12% and inflation of 5%  

 Before: Real= 12%-5%=7%  

 After: Real=.70(12)-5%=3.4%  

 —@ nominal interest rate of 5% and inflation of 4%  

 Before: Real=5%-4%=1%  

 After: Real=.70(5%)-4%=-0.5%  

Chapter 18: Open-Economy Macroeconomics: Basic Concepts  

 —net capital outflow  

 -the holdings of foreign assets by domestic residents minus the holdings of  domestic assets by foreigners (capital inflow)  

 -a company’s outflow always equals its net exports  

 —national saving equals domestic investment + net capital outflows   —the nominal exchange rate  

 -the price of the currency of the two countries  

 -when this rate changes and the US dollar is able to buy more foreign currency,  that means that the dollar has appreciated/strengthened  

 - when this rate changes and the US dollar is not able to buy as much foreign  currency, this means that the dollar has depreciated/weakened

 —the real exchange rate 

 -the relative price of the goods and services of two countries   —the theory of purchasing-power parity  

 -a dollar should be able to buy the same quantity of goods in all countries

 -this implies that the nominal exchange rate between the currencies of two  countries should reflect the price levels in those countries  

 -countries will high inflation should have depreciating currencies   -countries with low inflation should have appreciating currencies  

Calculating the Nominal Exchange Rate, the Real Exchange Rate and the Prices with  Purchasing-Power Parity 

 

—calculating the price of good X in country B  

 -start with formal for the nominal exchange rate  

 e=P*/P (P*) is the price level in the foreign country in the foreign currency  and P is the domestic price level in the domestic currency)  

 20A$(foreign currency)/B$(domestic currency)=5A$/P   -can now use algebra to solve for P  

 P(20A$)=(5A$)(B$)  

 -cancel out the A$  

 P=.25B$  

 —calculating the real exchange rate  

 -start with the formula  

 Real Exchange Rate=(e)(P)/P*

 =(20A$/B$ x .25B$)/5A$  

 -cancel out the B$  

 =5A$/5A$=1  

 —calculating pricing and rates in year 2027  

 -figure out price A:5A$ for 2027 (and starting at 2013)  

 -use Rule of 70: 10% divide that number into 70  

 -because 10 goes into 70 7 times, the price will double every seven years   -2013-2027=14 years so it will double TWICE  

 A: 5A$ x 2^2=20A$  

 -figure out price for B:.25B$  

 -Rule of 70: 5% into 70 and goes in 14 times  

 -from 2013-2027=14 years so the price will double just ONCE   B: 25B$ x 2=.5B$

 -nominal exchange rate  

 e=20A$/.5B$=40A$/B$  

 -real exchange rate  

 =(40A$/B$ x .5B$)/20A$  

 =20A$/20A$  

 =1 <— the same exchange rate calculated in the previous part of the  problem’ we discover that over time, while nominal exchange rate adjusts, the real exchange  rate stays the same  

 

Chapter 19: A Macroeconomic Theory of the Open Economy  

 —two markets are central to the macroeconomics of open economics   -the market for loanable funds

 -the market for foreign-currency exchange: the real interest rate adjusts to  balance the supply and demand of dollars  

 —when there is a government budget deficit  

 -a policy that reduces the national saving  

 -reduces the supply of loanable funds and drives up the interest rate   -because interest rates are higher, people do not hold as much money, the  dollar appreciates and net exports fall  

 —trade restrictions  

 -it increases net exports for any given exchange rate  

 -it increases the demand for dollars in the markets for foreign currency exchange   -the dollar appreciates in value and makes domestic goods seem more  expensive than foreign goods  

Chapter 20: Aggregate Demand and Aggregate Supply  

 —recessions  

 -RGDP, income, spending and production falls  

 -unemployment rises  

 —classical economy theory

 -based off of the assumption that nominal variables (money supply and price  level) do not influence real variables (output and unemployment)  

 -most believe this is accurate for the LR, not the SR  

 —the model of aggregate supply and aggregate demand (AD)  

 -economists use this model to analyze SR economic fluctuations   -the output of goods and services and overall price levels adjust to balance out  aggregate demand and aggregate supply  

 —the aggregate demand curve  

 -slopes downward due to the wealth effect, interest-rate effect and the  exchange rate effect  

 -any event or policy that raises C, I, G or NX at a given price increases AD   -any event that reduces C, I, G, NX at a given price decreases the AD   —the aggregate supply (AS) curve  

 -in the LR the curve is vertical

 -in the LR, the Q of goods and services supplied depends on the economy’s  labor, capital, natural resources and technology  

what about in the SR…?  

 —theories that have been proposed to explain the upward slope of the SRAS curve   -sticky-wage theory: an unanticipated fall in price levels temporarily raises real  wages through which firms then reduce employment and production  

 -stick-price theory: an unanticipated fall in price levels leaves firms with prices  that are too high through which then they have to reduce sales and cut back on production   -misperceptions theory: an unanticipated fall in price levels leads to reducing  production  

 —events that alter the economy's ability to produce output  

 -changes in labor, capital, natural resources and technology   —a shift in AD  

 -a possible cause of economic fluctuations  

 -when it shifts to the left, output and prices fall in the SR  

 -in the LR it all returns to natural level of output at a new, lower price level   —a shift in AS  

 -another possible cause for economic fluctuations  

 -when it shifts to the left, falling output and rising prices known as stagflation   -in the LR, shifts back and returns the P level and output to original levels  Extra Notes:  

 —in the LR, the increase in money growth will change the  

 -the inflation rate  

 -the price level  

 —the LRAS curve is a vertical line at the economy’s natural rate of output   —the position of the LRAS curve depends on the natural rate of unemployment    

Chapter 21: The Influence of Monetary and Fiscal Policy on Aggregate Demand    

 —Keynes: theory of liquidity preference

 -explains the determinants of the interest rate  

 -the interest rate adjusts to balance the supple and demand for money   —an increase in P level raises money demand and increases the interest rate that brings  the money market into equilibrium  

 —how policy makers can influence AD with monetary policy

 -an increase in the money supply reduces the equilibrium interest rate for an  given P level  

 -a lower interest rate stimulates investment spending and AD curve shifts to the  right  

 -the opposite happens when there is a decrease in the money supply   —how policy makers can influence AD with fiscal policy  

 -an increase in G or a cut in taxes shifts the AD curve to the right   -a decrease in G or increase in taxes shifts the AD curve to the left   —the crowding out effect

 -the offset in AD that results when expansionary fiscal policy raises the interest  rate and reduces investment spending  

 NOTE: this is was not discussed in class and so will likely NOT be on the final Chapter 22: The Short-Run Trade-off between Inflation and Unemployment   —The Phillips Curve  

 -illustrates the negative relationship between inflation and unemployment   -by expanding AD, can choose a point on the curve with higher inflation and  lower unemployment  

 -by contracting AD, can do the opposite  

 -the trade off between inflation and unemployment only holds in the SR   -the LR Phillips curve is vertical at the natural rate of unemployment    

 —supply shock  

 -an event that directly alters a firm’s costs and prices and shifts the AS curve and  the Phillips curve  

 —an adverse supply shock  

 i.e. increase in word oil prices

 gives policy makers a less favorable trade-off between inflation and  unemployment  

 the Phillips curve shifts

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