Two piers, A and B, are located on a river; B is 1500 m

3/15/15 Loanable funds market  Market that coordinates the borrowing and lending decisions of business firms and households o Price of loanable funds is the real interest rate “r”  “Real interest rate” means adjusted for inflation o Quantity of loanable funds is the amount saved or invested “Qs,I” o Similar to goods/services graph  Demand for loanable funds 1. Firms demand loanable funds (investment) 2. Downward sloping because as the interest rate decreases the firm will want to borrow more money o Increase in investment: demand cur Supply of loanable funds Individuals supply loanable funds (through savings) o Savings: after-tax income not spent on consumption  Incometaxesdisposable income consumption OR savings Upward sloping because as the interest rate increases people will want to save more o Increase in savings: supply curve will shift right o Decrease in savings: supply curve will shift left The interest rate  Nominal interest rate: the percentage of the amount borrowed that must be paid to the lender in addition to the repayment of the principle  Real interest rate: the interest rate adjusted for inflation (real cost of borrowing and lending money) o r = i – pi Interest rate and inflation  When the actual rate of inflation is greater than anticipated: borrowers gain, lenders lose  When the actual rate of inflation is less than anticipated” lenders gain, borrowers lose  Inflation does not help borrowers or lenders in a s systematic manner The interest rate and bond prices  Interest rate and bond prices are inversely rated  When the interest rate rises (falls), the market value of previously issued bonds will fall (rise) The foreign exchange market  Market in which the currencies of different countries are bought and sold o Price is price of foreign currency o Quantity is amount of foreign currency Changes in exchange rate  Appreciation: increase in value of currency relative to foreign currencies o Ex: dollar can buy more euros  Depreciation: reduction in value of currency relative to foreign currencies o Ex: dollar can buy less euros Demand for foreign currency  Demand for foreign currency is : imports + capital outflows o Capital outflows: domestic money invested abroad  Downward sloping because as dollar appreciates (foreign currency depreciates), people can import more and invest more in other countries Supple of foreign currency  Exports + capital inflows o Capital inflow: foreign money invested domestically  Upward sloping because as the dollar depreciates (foreign currency appreciates) foreign countries will demand more domestic exports and will invest more domestically o Demand increases: quantity increases, price of foreign currency increases o Demand decrease: quantity decreases, price of foreign currency decreases o Supply increases: quantity increases, price of foreign currency decreases o Supply decreases: quantity decreases, price of foreign currency increases 3/17/16 The foreign exchange market in equilibrium  Equilibrium occurs when supply of foreign currency equals demand for foreign currency o Imports + capital output = exports + capital input  Trade deficit: imports>exports o Capital output – capital input = exports – imports  Ex: 3 – 4 = 2 - 3  Trade surplus: exports> imports o Capital output – capital input = exports – imports  Ex: 5-4 = 6-5gn Aggregate goods/services market  A market that includes all final goods and services (counts all items that enter into GDP) o Example: we would not be looking at the supply and demand of pizza or haircuts or highways etc. it would be the supply and demand of pizza and haircuts and highways etc. o Price of all things (and on graphs): the price index (PI) o Quantity of all things (and on graphs): the real GDP (Y) o Includes 2 supply curves The aggregate demand curve Aggregate demand (AD) curve: the relationship between the price level and the quantity of domestically produced goods and services all households, business firms, governments and foreigners are willing to purchase o Downward sloping because as price level goes down, quantity demanded of all goods will increase 3 reasons why a decrease in price level will increase the quantity demanded of all goods 1. Increase the purchasing power of money  Graph: as PI decreases, Y will increase and shift to the right 2. Lead to a lower real interest rate, which increases consumption and investment  Graph: supply curve will shift to the right when you have more money in savings and the real interest rate will decrease. When real interest rate goes down, you will be less eager to put money in banks, thus you will start saving less and spend more.  r decreases  c increases, c increases  I increases  PI decreases  save more  r decreases  c increases, I increases  Y increase o WHEN PI DECREASES, Y INCREASES 3. Make domestically produced goods less expensive relative to foreign goods  Exports increase – imports The aggregate supple curve Relationship between a nations price level and the quantity of goods supplied by its producers o 2 relationships 1. Short-run aggregate supply curve 2. Long- run aggregate supply curve  Short run is time period in which something cannot be fixed, long run everything can be changed The short-run aggregate supply curve  Short-run aggregates supply curve (SRAS): upwards sloping because an increase in the price level will improve the profitability of the firms and cause them to increase output o Profit = revenue – cost o Ex: PI=1  revenue ($1x100) - cost ($100)= $0 o PI=2 revenue ($2x100) – cost ($100)= $100  Many of producers costa are still fixed The long-run aggregate supply curve  Long-run aggregate supply curve (LRAS): vertical because in the long-run people have had the time to adjust and so a higher price level will increase costs as much as it increases revenues o Profit = revenue – cost BUT ALL THINGS ARE UP FOR CHANGE o Ex: PI=1 revenue ($1x100)- cost ($100)= $0 o PI=2 revenue ($2x100)-cost ($200)=$0 o VERTICAL LINE ON GRAPH AT Y  Firms have no incentive to change production at any price level because in the long-run everything will balance out and profits wont change  Indicates potential output (Yf) of the economy  Where SRAS intersects LRAS: actual price level = expected price level Short-run equilibrium Occurs at the intersection of the AD and the SRAS o AD downward sloping, SRAS upward sloping o Intersection= e Long-run equilibrium  Occurs where AD, SRAS and LRAS all intersect at a single point o AD downward sloping, SRAS upward sloping, LRAS vertical line through intersection of AD and SRAS at point e o LRAS indicates wherever Yf is o Intersection is Y*  Yf = Y*  not in a recession, not in an expansion  Occurs when 1. We correctly anticipate price level 2. No expansion or recession (Y = Yf) 3. actual rate of unemployment = natural rate of unemployment ( U = U*)  If Yf is further left than Y*  expansion  If Yf is further right than Y* contraction ***think of the AD and SRAS as changing in the same way as all other graphs and ignore LRAS because all it is showing is the potential output, it is not actually there. Like yellow first-down line when watching football on tv, it is just there to help the viewer*** 3/15/15 Loanable funds market  Market that coordinates the borrowing and lending decisions of business firms and households o Price of loanable funds is the real interest rate “r”  “Real interest rate” means adjusted for inflation o Quantity of loanable funds is the amount saved or invested “Qs,I” o Similar to goods/services graph  Demand for loanable funds 1. Firms demand loanable funds (investment) 2. Downward sloping because as the interest rate decreases the firm will want to borrow more money o Increase in investment: demand cur Supply of loanable funds Individuals supply loanable funds (through savings) o Savings: after-tax income not spent on consumption  Incometaxesdisposable income consumption OR savings Upward sloping because as the interest rate increases people will want to save more o Increase in savings: supply curve will shift right o Decrease in savings: supply curve will shift left The interest rate  Nominal interest rate: the percentage of the amount borrowed that must be paid to the lender in addition to the repayment of the principle  Real interest rate: the interest rate adjusted for inflation (real cost of borrowing and lending money) o r = i – pi Interest rate and inflation  When the actual rate of inflation is greater than anticipated: borrowers gain, lenders lose  When the actual rate of inflation is less than anticipated” lenders gain, borrowers lose  Inflation does not help borrowers or lenders in a s systematic manner The interest rate and bond prices  Interest rate and bond prices are inversely rated  When the interest rate rises (falls), the market value of previously issued bonds will fall (rise) The foreign exchange market  Market in which the currencies of different countries are bought and sold o Price is price of foreign currency o Quantity is amount of foreign currency Changes in exchange rate  Appreciation: increase in value of currency relative to foreign currencies o Ex: dollar can buy more euros  Depreciation: reduction in value of currency relative to foreign currencies o Ex: dollar can buy less euros Demand for foreign currency  Demand for foreign currency is : imports + capital outflows o Capital outflows: domestic money invested abroad  Downward sloping because as dollar appreciates (foreign currency depreciates), people can import more and invest more in other countries Supple of foreign currency  Exports + capital inflows o Capital inflow: foreign money invested domestically  Upward sloping because as the dollar depreciates (foreign currency appreciates) foreign countries will demand more domestic exports and will invest more domestically o Demand increases: quantity increases, price of foreign currency increases o Demand decrease: quantity decreases, price of foreign currency decreases o Supply increases: quantity increases, price of foreign currency decreases o Supply decreases: quantity decreases, price of foreign currency increases 3/17/16 The foreign exchange market in equilibrium  Equilibrium occurs when supply of foreign currency equals demand for foreign currency o Imports + capital output = exports + capital input  Trade deficit: imports>exports o Capital output – capital input = exports – imports  Ex: 3 – 4 = 2 - 3  Trade surplus: exports> imports o Capital output – capital input = exports – imports  Ex: 5-4 = 6-5gn Aggregate goods/services market  A market that includes all final goods and services (counts all items that enter into GDP) o Example: we would not be looking at the supply and demand of pizza or haircuts or highways etc. it would be the supply and demand of pizza and haircuts and highways etc. o Price of all things (and on graphs): the price index (PI) o Quantity of all things (and on graphs): the real GDP (Y) o Includes 2 supply curves The aggregate demand curve Aggregate demand (AD) curve: the relationship between the price level and the quantity of domestically produced goods and services all households, business firms, governments and foreigners are willing to purchase o Downward sloping because as price level goes down, quantity demanded of all goods will increase 3 reasons why a decrease in price level will increase the quantity demanded of all goods 1. Increase the purchasing power of money  Graph: as PI decreases, Y will increase and shift to the right 2. Lead to a lower real interest rate, which increases consumption and investment  Graph: supply curve will shift to the right when you have more money in savings and the real interest rate will decrease. When real interest rate goes down, you will be less eager to put money in banks, thus you will start saving less and spend more.  r decreases  c increases, c increases  I increases  PI decreases  save more  r decreases  c increases, I increases  Y increase o WHEN PI DECREASES, Y INCREASES 3. Make domestically produced goods less expensive relative to foreign goods  Exports increase – imports The aggregate supple curve Relationship between a nations price level and the quantity of goods supplied by its producers o 2 relationships 1. Short-run aggregate supply curve 2. Long- run aggregate supply curve  Short run is time period in which something cannot be fixed, long run everything can be changed The short-run aggregate supply curve  Short-run aggregates supply curve (SRAS): upwards sloping because an increase in the price level will improve the profitability of the firms and cause them to increase output o Profit = revenue – cost o Ex: PI=1  revenue ($1x100) - cost ($100)= $0 o PI=2 revenue ($2x100) – cost ($100)= $100  Many of producers costa are still fixed The long-run aggregate supply curve  Long-run aggregate supply curve (LRAS): vertical because in the long-run people have had the time to adjust and so a higher price level will increase costs as much as it increases revenues o Profit = revenue – cost BUT ALL THINGS ARE UP FOR CHANGE o Ex: PI=1 revenue ($1x100)- cost ($100)= $0 o PI=2 revenue ($2x100)-cost ($200)=$0 o VERTICAL LINE ON GRAPH AT Y  Firms have no incentive to change production at any price level because in the long-run everything will balance out and profits wont change  Indicates potential output (Yf) of the economy  Where SRAS intersects LRAS: actual price level = expected price level Short-run equilibrium Occurs at the intersection of the AD and the SRAS o AD downward sloping, SRAS upward sloping o Intersection= e Long-run equilibrium  Occurs where AD, SRAS and LRAS all intersect at a single point o AD downward sloping, SRAS upward sloping, LRAS vertical line through intersection of AD and SRAS at point e o LRAS indicates wherever Yf is o Intersection is Y*  Yf = Y*  not in a recession, not in an expansion  Occurs when 1. We correctly anticipate price level 2. No expansion or recession (Y = Yf) 3. actual rate of unemployment = natural rate of unemployment ( U = U*)  If Yf is further left than Y*  expansion  If Yf is further right than Y* contraction ***think of the AD and SRAS as changing in the same way as all other graphs and ignore LRAS because all it is showing is the potential output, it is not actually there. Like yellow first-down line when watching football on tv, it is just there to help the viewer***