The Aggregate Demand Schedule

Size: px
Start display at page:

Download "The Aggregate Demand Schedule"

Transcription

1 The Aggregate Demand Schedule Pedro Serôdio July 20, 2016

2 Learning objectives To understand: An essential part of the tool-kit. How the quantity theory of money, IS-LM and IS-MP models give rise to the Aggregate Demand curve. The potential importance of wealth effects and forwardlooking behaviour for Aggregate Demand. How various assumptions about expectations, the workings of the labour market, and price-setting affect the shape of the Aggregate Supply curve and give rise to different empirical predictions and policy prescriptions.options.

3 Outline Derivation of AD curve in the IS-LM, quantity theory and IS-MP models. The slope of the AD curve. Wealth effects.

4 The AD schedule The AD curve shows combinations of the price level and real output (for the IS-LM and quantity theory models) and between inflation and real output gap for the IS-MP model. In any of these 1. Actual and planned expenditure on real output are equal; 2. The price level (inflation) and real output (output gap) correspond to an equilibrium in the money market (or operation of the monetary rule). The AD curve plots the price level (inflation rate) at which the IS and LM (MP) curves intersect, for all levels of output gap (the output gap).

5 The AD schedule Taking the expression for equilibrium output in the IS-LM model, we have that: y = h (1 c)h + dk (a ct + b + g) + d (m p) (1 c)h + dk Differentiating p with respect to y, we get: p y = (1 c)h + dk d Which gives us the slope of the aggregate demand schedule in (p, y) space.

6 The AD schedule In the IS-MP framework, the equilibrium level of output is given by: y 1 = (a ct + b + g) + 1 c dφ y d + ( r + φ y ȳ φ π π) 1 c dφ y Differentiating π with respect to y, we get: π y = (1 c) + dφ y dφ π Which gives us the slope of the aggregate demand schedule in (π, y) space.

7 The AD schedule The equation of exchange and the aggregate demand schedule. The equation of exchange is a useful identity that holds in any monetary economy and is a useful starting point for a number of important theories: MV PY, where M is total amount of money, V the velocity of transactions, P the aggregate price level and Y the level of output. Here, we focus on the implicit relationship it has for the shape of the aggregate demand schedule. Solving the equation for P, we have: P = Ms V (i) Y

8 The AD schedule Taking logs, we have: p = m + ηi y Notice that this is simply an alternative formulation for a linear money demand function: (m p) d = y ηi Under this specification, the aggregate demand schedule will again be a negative function of the price level and, therefore, the aggregate demand schedule will be downward sloping.

9 Aggregate Demand MP 0 r MP 1 A π A B B IS y The AD curve has a negative slope in (p, y) space p y < 0. as long as: 1. The real rate rises when output increases because the money supply falls. 2. A rise in the real interest rate is associated with a fall in real output. These effects can be shown in r y space, as here, or in a combination of r π and r y spaces. AD y

10 Aggregate Demand r MP 0 π IS 1 IS 0 y AD 1 AD 0 y The AD curve will be flatter in (p, y) space: 1. The larger is the MPC; 2. The larger is the responsiveness of consumption and investment to the real interest rate C r, I r (d in the expression above) (shown left). 3. The less monetary policy responds to output fluctuations (the lower is φ y ); 4. The more monetary policy responds to inflation fluctuations (the larger is φ π );

11 Criticism The MP model improves on the LM model by more accurately capturing policy and response to inflation. It is possible to criticise the basic IS curve: 1. The interest rate relevant for spending might differ from the policy target rate. 2. Wealth effects are absent, though they can be added to the model (we ll discuss these ahead). 3. A third objection is that the IS curve remains Keynesian in nature. It is static and not explicitly microfounded. An alternative, microfounded, Dynamic IS curve (DIS) has been developed, and is currently used in modern New Keynesian models, which we ll cover in when we discuss the New Keynesian model.

12 Aggregate Demand r IS 1 LM 0 A special case of the aggregate demand schedule occurs when the interest sensitivity of both investment and consumption to the interest rate is zero. IS 0 y We know that the slope of the aggregate demand schedule is given by: π AD 1 p y = (1 c)h + dk d Taking the limit as d 0, it is clear that: AD 0 y p lim d 0 y =

13 Aggregate Demand If the planned expenditure function (here, planned consumption and investment) is interest-inelastic C r = 0, I r = 0, where C r is the interest elasticity of consumption and I r interest elasticity of investment), then monetary policy is ineffective : it cannot alter output, although it can affect the price level. If AS is also inflation-inelastic, an AD-AS equilibrium might not exist. In that case, if the AD curve lies to the left of the AS curve, the level of output is demand- determined. Furthermore, the excess supply could not be eliminated by disinflation or falling prices.

14 The Pigou effect A response of consumption to real wealth can be captured fairly easily by simply making consumption respond directly to wealth. This effect is named the Pigou effect, after Cambridge economist Arthur C. Pigou. Pigou suggested real wealth could be modelled as A = M/P + (P B /P)B, but Ricardian Equivalence (Barro: government bonds are not net wealth) would suggest just including real money balances. The Pigou effect is also known as the real balance effect. How does the Pigou effect operate? A reduction in the price level raises consumers net real wealth at any given income level. Reducing saving (since there is less need to accumulate wealth to fund future consumption) and Increasing current consumption demand.

15 The Pigou effect Going back the planned expenditure function introduced earlier, we can see that consumption depends partly on the amount of assets owned by the households. Recall that: Y = C (Y T, r, MP + Pb P B ), where 0 < C A < 1 Real balances, MS/P, affect the position of the IS curve. A rise in real balances shifts the IS schedule outwards, for any given level of the real interest rate. The Pigou effect is probably best known for its implications concerning the effect of deflation - and the consequences for the possibility of a liquidity trap. If the Pigou effect operates, a reduction in the price level can cause a direct increase in AD. Direct effect: It occurs even without a reduction in the interest rate.

16 The Pigou effect Deflation is more expansionary. The AD curve is flatter than it otherwise would be. In a liquidity trap (not shown here), the Pigou effect acts contrary to the negative impact of deflation via the autonomous rise in the real interest rate p and via expectations of future lower prices. In practice, real money balances are a small fraction of real wealth. The marginal propensity to consume out of real wealth is estimated to be about C A = 0.1, whereas that out of disposable income is around C Y = 0.8. Thus the size of the Pigou effect is likely to be small.

17 The Pigou effect The type of money supply increase relevant here is a helicopter drop. Ricardian Equivalence states that government bonds are not net wealth, implying that an increase in the money supply due to central bank bond purchase would also increase net wealth. But: Does Ricardian Equivalence hold? If not, bond-money swaps have less/no effect on net wealth. If their nominal value (asset price) remained unaltered, the real value of other forms of wealth would also rise following deflation, which could boost consumption through a wealth effect. However, price deflation - particularly in a liquidity trap - is often accompanied by falls in asset prices (so no increase in real wealth from that source).

18 The Tobin-Fisher effect The Tobin-Fisher effect is also known as the redistribution effect, or the debt-deflation effect. An unexpected reduction in the price level (deflation) can cause a direct decrease in AD, if it changes the distribution of wealth from high-spending borrowers to low-spending lenders.

19 The Tobin-Fisher effect: Intuition Debt contracts are usually set in nominal terms, i.e. they specify interest (and capital) payments in money value. Suppose that there is a reduction in the price level that was not anticipated by either creditors or debtors at the time of signing the debt contract. Moreover, suppose that the nominal debt contract is neither indexed to the price level, nor can be renegotiated by the parties.

20 The Tobin-Fisher effect: Intuition Borrowers (e.g. people with mortgages, entrepreneurs, farmers) see that the real value of their debt has increased, which implies that lenders (banks, savers) receive more payments in real terms. In other words, there is a redistribution from debtors to creditors. If debtors have a higher marginal propensity to spend than creditors, this redistribution effect causes a reduction in AD: creditors spend a smaller fraction of their additional income, and debtors are forced to cut back consumption and investment to reduce/repay their debts. Eventually, debtors can become insolvent (e.g. firms can shut down plants).

21 The Tobin-Fisher effect: Intuition r LM 0 LM 1 A C B IS 0 The Tobin-Fisher wealth redistribution effect counteracts monetary policy The AD curve is steeper than it otherwise would be. π A C B IS 1 y In a liquidity trap (not shown here), the Tobin-Fisher effect adds to the negative impact of deflation via the autonomous rise in the real interest rate and via expectations of future lower prices. AD 1 AD 0 y

22 Summary and Look Forward We have defined the AD curve. We have seen what determines its slope. You should also make sure that you can pinpoint everything that will shift the AD curve. The simple AD model can be extended to capture financial frictions, confidence and wealth effects, which all affect the IS curve. - These are important to capture accurately responses to financial crises, monetary expansion and deflation. We will see ahead that the static IS curve can be replaced with a dynamic version. Next: We summarise what the AS curve looks like under various assumptions about wage-setting, price-setting and expectations.

In this chapter we learn the potential causes of fluctuations in national income. We focus on demand shocks other than supply shocks.

In this chapter we learn the potential causes of fluctuations in national income. We focus on demand shocks other than supply shocks. Chapter 11: Applying IS-LM Model In this chapter we learn the potential causes of fluctuations in national income. We focus on demand shocks other than supply shocks. We also learn how the IS-LM model

More information

BADM 527, Fall 2013. Midterm Exam 2. Multiple Choice: 3 points each. Answer the questions on the separate bubble sheet. NAME

BADM 527, Fall 2013. Midterm Exam 2. Multiple Choice: 3 points each. Answer the questions on the separate bubble sheet. NAME BADM 527, Fall 2013 Name: Midterm Exam 2 November 7, 2013 Multiple Choice: 3 points each. Answer the questions on the separate bubble sheet. NAME 1. According to classical theory, national income (Real

More information

Aggregate Demand, Aggregate Supply, and the Self-Correcting Economy

Aggregate Demand, Aggregate Supply, and the Self-Correcting Economy Aggregate Demand, Aggregate Supply, and the Self-Correcting Economy The Role of Aggregate Demand & Supply Endogenizing the Price Level Inflation Deflation Price Stability The Aggregate Demand Curve Relates

More information

Econ 303: Intermediate Macroeconomics I Dr. Sauer Sample Questions for Exam #3

Econ 303: Intermediate Macroeconomics I Dr. Sauer Sample Questions for Exam #3 Econ 303: Intermediate Macroeconomics I Dr. Sauer Sample Questions for Exam #3 1. When firms experience unplanned inventory accumulation, they typically: A) build new plants. B) lay off workers and reduce

More information

Keynesian Macroeconomic Theory

Keynesian Macroeconomic Theory 2 Keynesian Macroeconomic Theory 2.1. The Keynesian Consumption Function 2.2. The Complete Keynesian Model 2.3. The Keynesian-Cross Model 2.4. The IS-LM Model 2.5. The Keynesian AD-AS Model 2.6. Conclusion

More information

0 100 200 300 Real income (Y)

0 100 200 300 Real income (Y) Lecture 11-1 6.1 The open economy, the multiplier, and the IS curve Assume that the economy is either closed (no foreign trade) or open. Assume that the exchange rates are either fixed or flexible. Assume

More information

Chapter 9. The IS-LM/AD-AS Model: A General Framework for Macroeconomic Analysis. 2008 Pearson Addison-Wesley. All rights reserved

Chapter 9. The IS-LM/AD-AS Model: A General Framework for Macroeconomic Analysis. 2008 Pearson Addison-Wesley. All rights reserved Chapter 9 The IS-LM/AD-AS Model: A General Framework for Macroeconomic Analysis Chapter Outline The FE Line: Equilibrium in the Labor Market The IS Curve: Equilibrium in the Goods Market The LM Curve:

More information

S.Y.B.COM. (SEM-III) ECONOMICS

S.Y.B.COM. (SEM-III) ECONOMICS Fill in the Blanks. Module 1 S.Y.B.COM. (SEM-III) ECONOMICS 1. The continuous flow of money and goods and services between firms and households is called the Circular Flow. 2. Saving constitute a leakage

More information

Use the following to answer question 9: Exhibit: Keynesian Cross

Use the following to answer question 9: Exhibit: Keynesian Cross 1. Leading economic indicators are: A) the most popular economic statistics. B) data that are used to construct the consumer price index and the unemployment rate. C) variables that tend to fluctuate in

More information

ECO209 MACROECONOMIC THEORY. Chapter 11

ECO209 MACROECONOMIC THEORY. Chapter 11 Prof. Gustavo Indart Department of Economics University of Toronto ECO209 MACROECONOMIC THEORY Chapter 11 MONEY, INTEREST, AND INCOME Discussion Questions: 1. The model in Chapter 9 assumed that both the

More information

Study Questions 8 (Keynesian Model) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

Study Questions 8 (Keynesian Model) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Study Questions 8 (Keynesian Model) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) In the Keynesian model of aggregate expenditure, real GDP is

More information

8. Simultaneous Equilibrium in the Commodity and Money Markets

8. Simultaneous Equilibrium in the Commodity and Money Markets Lecture 8-1 8. Simultaneous Equilibrium in the Commodity and Money Markets We now combine the IS (commodity-market equilibrium) and LM (money-market equilibrium) schedules to establish a general equilibrium

More information

MONETARY AND FISCAL POLICY IN THE VERY SHORT RUN

MONETARY AND FISCAL POLICY IN THE VERY SHORT RUN C H A P T E R12 MONETARY AND FISCAL POLICY IN THE VERY SHORT RUN LEARNING OBJECTIVES After reading and studying this chapter, you should be able to: Understand that both fiscal and monetary policy can

More information

The IS-LM Model Ing. Mansoor Maitah Ph.D.

The IS-LM Model Ing. Mansoor Maitah Ph.D. The IS-LM Model Ing. Mansoor Maitah Ph.D. Constructing the Keynesian Cross Equilibrium is at the point where Y = C + I + G. If firms were producing at Y 1 then Y > E Because actual expenditure exceeds

More information

13 EXPENDITURE MULTIPLIERS: THE KEYNESIAN MODEL* Chapter. Key Concepts

13 EXPENDITURE MULTIPLIERS: THE KEYNESIAN MODEL* Chapter. Key Concepts Chapter 3 EXPENDITURE MULTIPLIERS: THE KEYNESIAN MODEL* Key Concepts Fixed Prices and Expenditure Plans In the very short run, firms do not change their prices and they sell the amount that is demanded.

More information

I d ( r; MPK f, τ) Y < C d +I d +G

I d ( r; MPK f, τ) Y < C d +I d +G 1. Use the IS-LM model to determine the effects of each of the following on the general equilibrium values of the real wage, employment, output, the real interest rate, consumption, investment, and the

More information

2. With an MPS of.4, the MPC will be: A) 1.0 minus.4. B).4 minus 1.0. C) the reciprocal of the MPS. D).4. Answer: A

2. With an MPS of.4, the MPC will be: A) 1.0 minus.4. B).4 minus 1.0. C) the reciprocal of the MPS. D).4. Answer: A 1. If Carol's disposable income increases from $1,200 to $1,700 and her level of saving increases from minus $100 to a plus $100, her marginal propensity to: A) save is three-fifths. B) consume is one-half.

More information

Answer: C Learning Objective: Money supply Level of Learning: Knowledge Type: Word Problem Source: Unique

Answer: C Learning Objective: Money supply Level of Learning: Knowledge Type: Word Problem Source: Unique 1.The aggregate demand curve shows the relationship between inflation and: A) the nominal interest rate. D) the exchange rate. B) the real interest rate. E) short-run equilibrium output. C) the unemployment

More information

INTRODUCTION AGGREGATE DEMAND MACRO EQUILIBRIUM MACRO EQUILIBRIUM THE DESIRED ADJUSTMENT THE DESIRED ADJUSTMENT

INTRODUCTION AGGREGATE DEMAND MACRO EQUILIBRIUM MACRO EQUILIBRIUM THE DESIRED ADJUSTMENT THE DESIRED ADJUSTMENT Chapter 9 AGGREGATE DEMAND INTRODUCTION The Great Depression was a springboard for the Keynesian approach to economic policy. Keynes asked: What are the components of aggregate demand? What determines

More information

= C + I + G + NX ECON 302. Lecture 4: Aggregate Expenditures/Keynesian Model: Equilibrium in the Goods Market/Loanable Funds Market

= C + I + G + NX ECON 302. Lecture 4: Aggregate Expenditures/Keynesian Model: Equilibrium in the Goods Market/Loanable Funds Market Intermediate Macroeconomics Lecture 4: Introduction to the Goods Market Review of the Aggregate Expenditures model and the Keynesian Cross ECON 302 Professor Yamin Ahmad Components of Aggregate Demand

More information

Government Budget and Fiscal Policy CHAPTER

Government Budget and Fiscal Policy CHAPTER Government Budget and Fiscal Policy 11 CHAPTER The National Budget The national budget is the annual statement of the government s expenditures and tax revenues. Fiscal policy is the use of the federal

More information

12.1 Introduction. 12.2 The MP Curve: Monetary Policy and the Interest Rates 1/24/2013. Monetary Policy and the Phillips Curve

12.1 Introduction. 12.2 The MP Curve: Monetary Policy and the Interest Rates 1/24/2013. Monetary Policy and the Phillips Curve Chapter 12 Monetary Policy and the Phillips Curve By Charles I. Jones Media Slides Created By Dave Brown Penn State University The short-run model summary: Through the MP curve the nominal interest rate

More information

For a closed economy, the national income identity is written as Y = F (K; L)

For a closed economy, the national income identity is written as Y = F (K; L) A CLOSED ECONOMY IN THE LONG (MEDIUM) RUN For a closed economy, the national income identity is written as Y = C(Y T ) + I(r) + G the left hand side of the equation is the total supply of goods and services

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Econ 111 Summer 2007 Final Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The classical dichotomy allows us to explore economic growth

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Suvey of Macroeconomics, MBA 641 Fall 2006, Final Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Modern macroeconomics emerged from

More information

Factors that Shift the IS Curve

Factors that Shift the IS Curve Factors that Shift the IS Curve A change in autonomous factors that is unrelated to the interest rate Changes in autonomous consumer expenditure Changes in planned investment spending unrelated to the

More information

Lecture 12-1. Interest Rates. 1. RBA Objectives and Instruments

Lecture 12-1. Interest Rates. 1. RBA Objectives and Instruments Lecture 12-1 Interest Rates 1. RBA Objectives and Instruments The Reserve Bank of Australia has several objectives, including the stability of the currency, the maintenance of full employment. These two

More information

Pre-Test Chapter 8 ed17

Pre-Test Chapter 8 ed17 Pre-Test Chapter 8 ed17 Multiple Choice Questions 1. The APC can be defined as the fraction of a: A. change in income that is not spent. B. change in income that is spent. C. specific level of total income

More information

The level of price and inflation Real GDP: the values of goods and services measured using a constant set of prices

The level of price and inflation Real GDP: the values of goods and services measured using a constant set of prices Chapter 2: Key Macroeconomics Variables ECON2 (Spring 20) 2 & 4.3.20 (Tutorial ) National income accounting Gross domestic product (GDP): The market value of all final goods and services produced within

More information

2.If actual investment is greater than planned investment, inventories increase more than planned. TRUE.

2.If actual investment is greater than planned investment, inventories increase more than planned. TRUE. Macro final exam study guide True/False questions - Solutions Case, Fair, Oster Chapter 8 Aggregate Expenditure and Equilibrium Output 1.Firms react to unplanned inventory investment by reducing output.

More information

ECON 3312 Macroeconomics Exam 3 Fall 2014. Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

ECON 3312 Macroeconomics Exam 3 Fall 2014. Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. ECON 3312 Macroeconomics Exam 3 Fall 2014 Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Everything else held constant, an increase in net

More information

The Aggregate Demand- Aggregate Supply (AD-AS) Model

The Aggregate Demand- Aggregate Supply (AD-AS) Model The AD-AS Model The Aggregate Demand- Aggregate Supply (AD-AS) Model Chapter 9 The AD-AS Model addresses two deficiencies of the AE Model: No explicit modeling of aggregate supply. Fixed price level. 2

More information

CHAPTER 7: AGGREGATE DEMAND AND AGGREGATE SUPPLY

CHAPTER 7: AGGREGATE DEMAND AND AGGREGATE SUPPLY CHAPTER 7: AGGREGATE DEMAND AND AGGREGATE SUPPLY Learning goals of this chapter: What forces bring persistent and rapid expansion of real GDP? What causes inflation? Why do we have business cycles? How

More information

Econ 202 Final Exam. Table 3-1 Labor Hours Needed to Make 1 Pound of: Meat Potatoes Farmer 8 2 Rancher 4 5

Econ 202 Final Exam. Table 3-1 Labor Hours Needed to Make 1 Pound of: Meat Potatoes Farmer 8 2 Rancher 4 5 Econ 202 Final Exam 1. If inflation expectations rise, the short-run Phillips curve shifts a. right, so that at any inflation rate unemployment is higher. b. left, so that at any inflation rate unemployment

More information

Sample Midterm Solutions

Sample Midterm Solutions Sample Midterm Solutions Instructions: Please answer both questions. You should show your working and calculations for each applicable problem. Correct answers without working will get you relatively few

More information

M.A.PART - I ECONOMIC PAPER - I MACRO ECONOMICS

M.A.PART - I ECONOMIC PAPER - I MACRO ECONOMICS 1 M.A.PART - I ECONOMIC PAPER - I MACRO ECONOMICS 1. Basic Macroeconomics Income and spending The consumption function Savings and investment The Keynesian Multiplier The budget Balanced budget : theorem

More information

CHAPTER 9 Building the Aggregate Expenditures Model

CHAPTER 9 Building the Aggregate Expenditures Model CHAPTER 9 Building the Aggregate Expenditures Model Topic Question numbers 1. Consumption function/apc/mpc 1-42 2. Saving function/aps/mps 43-56 3. Shifts in consumption and saving functions 57-72 4 Graphs/tables:

More information

ANSWERS TO END-OF-CHAPTER QUESTIONS

ANSWERS TO END-OF-CHAPTER QUESTIONS ANSWERS TO END-OF-CHAPTER QUESTIONS 9-1 Explain what relationships are shown by (a) the consumption schedule, (b) the saving schedule, (c) the investment-demand curve, and (d) the investment schedule.

More information

Agenda. The IS LM Model, Part 2. The Demand for Money. The Demand for Money. The Demand for Money. Asset Market Equilibrium.

Agenda. The IS LM Model, Part 2. The Demand for Money. The Demand for Money. The Demand for Money. Asset Market Equilibrium. Agenda The IS LM Model, Part 2 Asset Market Equilibrium The LM Curve 13-1 13-2 The demand for money is the quantity of money people want to hold in their portfolios. The demand for money depends on expected

More information

Chapter 11. Keynesianism: The Macroeconomics of Wage and Price Rigidity. 2008 Pearson Addison-Wesley. All rights reserved

Chapter 11. Keynesianism: The Macroeconomics of Wage and Price Rigidity. 2008 Pearson Addison-Wesley. All rights reserved Chapter 11 Keynesianism: The Macroeconomics of Wage and Price Rigidity Chapter Outline Real-Wage Rigidity Price Stickiness Monetary and Fiscal Policy in the Keynesian Model The Keynesian Theory of Business

More information

Answers to Text Questions and Problems. Chapter 22. Answers to Review Questions

Answers to Text Questions and Problems. Chapter 22. Answers to Review Questions Answers to Text Questions and Problems Chapter 22 Answers to Review Questions 3. In general, producers of durable goods are affected most by recessions while producers of nondurables (like food) and services

More information

Chapter 12 Unemployment and Inflation

Chapter 12 Unemployment and Inflation Chapter 12 Unemployment and Inflation Multiple Choice Questions 1. The origin of the idea of a trade-off between inflation and unemployment was a 1958 article by (a) A.W. Phillips. (b) Edmund Phelps. (c)

More information

Chapter 12. Aggregate Expenditure and Output in the Short Run

Chapter 12. Aggregate Expenditure and Output in the Short Run Chapter 12. Aggregate Expenditure and Output in the Short Run Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON 203 502 Principles of Macroeconomics Aggregate Expenditure (AE)

More information

Business Conditions Analysis Prof. Yamin Ahmad ECON 736

Business Conditions Analysis Prof. Yamin Ahmad ECON 736 Business Conditions Analysis Prof. Yamin Ahmad ECON 736 Sample Final Exam Name Id # Instructions: There are two parts to this midterm. Part A consists of multiple choice questions. Please mark the answers

More information

This paper is not to be removed from the Examination Halls

This paper is not to be removed from the Examination Halls This paper is not to be removed from the Examination Halls UNIVERSITY OF LONDON EC2065 ZA BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the Social Sciences, the Diplomas

More information

Study Questions for Chapter 9 (Answer Sheet)

Study Questions for Chapter 9 (Answer Sheet) DEREE COLLEGE DEPARTMENT OF ECONOMICS EC 1101 PRINCIPLES OF ECONOMICS II FALL SEMESTER 2002 M-W-F 13:00-13:50 Dr. Andreas Kontoleon Office hours: Contact: a.kontoleon@ucl.ac.uk Wednesdays 15:00-17:00 Study

More information

Topic 4: Introduction to Labour Market, Aggregate Supply and AD-AS model

Topic 4: Introduction to Labour Market, Aggregate Supply and AD-AS model Topic 4: Introduction to Labour Market, Aggregate Supply and AD-AS model 1. In order to model the labour market at a microeconomic level, e simplify greatly by assuming that all jobs are the same in terms

More information

Problem Set 5. a) In what sense is money neutral? Why is monetary policy useful if money is neutral?

Problem Set 5. a) In what sense is money neutral? Why is monetary policy useful if money is neutral? 1 Problem Set 5 Question 2 a) In what sense is money neutral? Why is monetary policy useful if money is neutral? In Problem Set 4, Question 2-Part (e), we already analysed the effect of an expansionary

More information

Macroeconomics, Fall 2007 Exam 3, TTh classes, various versions

Macroeconomics, Fall 2007 Exam 3, TTh classes, various versions Name: _ Days/Times Class Meets: Today s Date: Macroeconomics, Fall 2007 Exam 3, TTh classes, various versions Read these Instructions carefully! You must follow them exactly! I) On your Scantron card you

More information

Answers to Text Questions and Problems in Chapter 8

Answers to Text Questions and Problems in Chapter 8 Answers to Text Questions and Problems in Chapter 8 Answers to Review Questions 1. The key assumption is that, in the short run, firms meet demand at pre-set prices. The fact that firms produce to meet

More information

Practiced Questions. Chapter 20

Practiced Questions. Chapter 20 Practiced Questions Chapter 20 1. The model of aggregate demand and aggregate supply a. is different from the model of supply and demand for a particular market, in that we cannot focus on the substitution

More information

1. a. Interest-bearing checking accounts make holding money more attractive. This increases the demand for money.

1. a. Interest-bearing checking accounts make holding money more attractive. This increases the demand for money. Macroeconomics ECON 2204 Prof. Murphy Problem Set 4 Answers Chapter 10 #1, 2, and 3 (on pages 308-309) 1. a. Interest-bearing checking accounts make holding money more attractive. This increases the demand

More information

The Keynesian Cross. A Fixed Price Level. The Simplest Keynesian-Cross Model: Autonomous Consumption Only

The Keynesian Cross. A Fixed Price Level. The Simplest Keynesian-Cross Model: Autonomous Consumption Only The Keynesian Cross Some instructors like to develop a more detailed macroeconomic model than is presented in the textbook. This supplemental material provides a concise description of the Keynesian-cross

More information

BUSINESS ECONOMICS CEC2 532-751 & 761

BUSINESS ECONOMICS CEC2 532-751 & 761 BUSINESS ECONOMICS CEC2 532-751 & 761 PRACTICE MACROECONOMICS MULTIPLE CHOICE QUESTIONS Warning: These questions have been posted to give you an opportunity to practice with the multiple choice format

More information

a) Aggregate Demand (AD) and Aggregate Supply (AS) analysis

a) Aggregate Demand (AD) and Aggregate Supply (AS) analysis a) Aggregate Demand (AD) and Aggregate Supply (AS) analysis Determinants of AD: Aggregate demand is the total demand in the economy. It measures spending on goods and services by consumers, firms, the

More information

University of Lethbridge Department of Economics ECON 1012 Introduction to Macroeconomics Instructor: Michael G. Lanyi

University of Lethbridge Department of Economics ECON 1012 Introduction to Macroeconomics Instructor: Michael G. Lanyi University of Lethbridge Department of Economics ECON 1012 Introduction to Macroeconomics Instructor: Michael G. Lanyi CH 27 Expenditure Multipliers 1) Disposable income is A) aggregate income minus transfer

More information

Chapter 13. Aggregate Demand and Aggregate Supply Analysis

Chapter 13. Aggregate Demand and Aggregate Supply Analysis Chapter 13. Aggregate Demand and Aggregate Supply Analysis Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON 203 502 Principles of Macroeconomics In the short run, real GDP and

More information

. In this case the leakage effect of tax increases is mitigated because some of the reduction in disposable income would have otherwise been saved.

. In this case the leakage effect of tax increases is mitigated because some of the reduction in disposable income would have otherwise been saved. Chapter 4 Review Questions. Explain how an increase in government spending and an equal increase in lump sum taxes can generate an increase in equilibrium output. Under what conditions will a balanced

More information

AGGREGATE DEMAND AND AGGREGATE SUPPLY The Influence of Monetary and Fiscal Policy on Aggregate Demand

AGGREGATE DEMAND AND AGGREGATE SUPPLY The Influence of Monetary and Fiscal Policy on Aggregate Demand AGGREGATE DEMAND AND AGGREGATE SUPPLY The Influence of Monetary and Fiscal Policy on Aggregate Demand Suppose that the economy is undergoing a recession because of a fall in aggregate demand. a. Using

More information

Practice Problems on Money and Monetary Policy

Practice Problems on Money and Monetary Policy Practice Problems on Money and Monetary Policy 1- Define money. How does the economist s use of this term differ from its everyday meaning? Money is the economist s term for assets that can be used in

More information

University of Lethbridge Department of Economics ECON 1012 Introduction to Microeconomics Instructor: Michael G. Lanyi. Chapter 29 Fiscal Policy

University of Lethbridge Department of Economics ECON 1012 Introduction to Microeconomics Instructor: Michael G. Lanyi. Chapter 29 Fiscal Policy University of Lethbridge Department of Economics ECON 1012 Introduction to Microeconomics Instructor: Michael G. Lanyi Chapter 29 Fiscal Policy 1) If revenues exceed outlays, the government's budget balance

More information

Chapter 4 Consumption, Saving, and Investment

Chapter 4 Consumption, Saving, and Investment Chapter 4 Consumption, Saving, and Investment Multiple Choice Questions 1. Desired national saving equals (a) Y C d G. (b) C d + I d + G. (c) I d + G. (d) Y I d G. 2. With no inflation and a nominal interest

More information

Introduction to Economics, ECON 100:11 & 13 Multiplier Model

Introduction to Economics, ECON 100:11 & 13 Multiplier Model Introduction to Economics, ECON 1:11 & 13 We will now rationalize the shape of the aggregate demand curve, based on the identity we have used previously, AE=C+I+G+(X-IM). We will in the process develop

More information

International Macroeconommics

International Macroeconommics International Macroeconommics Chapter 7. The Open Economy IS-LM Model Department of Economics, UCDavis Outline 1 Building the IS-LM-FX Model 2 Monetary Policy Fiscal Policy Outline Building the IS-LM-FX

More information

FISCAL POLICY* Chapter. Key Concepts

FISCAL POLICY* Chapter. Key Concepts Chapter 11 FISCAL POLICY* Key Concepts The Federal Budget The federal budget is an annual statement of the government s expenditures and tax revenues. Using the federal budget to achieve macroeconomic

More information

The Keynesian Total Expenditures Model

The Keynesian Total Expenditures Model The Keynesian Total Expenditures Model LEARNING OBJECTIVES 1. Draw the consumption function and explain its appearance. 2. Discuss the factors that will shift the consumption function to a new position.

More information

Lecture 11: Inflation: Its Causes and Costs. Rob Godby University of Wyoming

Lecture 11: Inflation: Its Causes and Costs. Rob Godby University of Wyoming Lecture 11: Inflation: Its Causes and Costs Rob Godby University of Wyoming Inflation: Definition Inflation is a sustained, continuous increase in the price level. It does not refer to a once-and-for-all

More information

Case, Fair and Oster Macroeconomics Chapter 11 Problems Money Demand and the Equilibrium Interest Rate

Case, Fair and Oster Macroeconomics Chapter 11 Problems Money Demand and the Equilibrium Interest Rate Case, Fair and Oster Macroeconomics Chapter 11 Problems Money Demand and the Equilibrium Interest Rate Money demand equation. P Y Md = k * -------- where k = percent of nominal income held as money ( Cambridge

More information

Chapter 12: Aggregate Supply and Phillips Curve

Chapter 12: Aggregate Supply and Phillips Curve Chapter 12: Aggregate Supply and Phillips Curve In this chapter we explain the position and slope of the short run aggregate supply (SRAS) curve. SRAS curve can also be relabeled as Phillips curve. A basic

More information

Chapter 9 Aggregate Demand and Economic Fluctuations Macroeconomics In Context (Goodwin, et al.)

Chapter 9 Aggregate Demand and Economic Fluctuations Macroeconomics In Context (Goodwin, et al.) Chapter 9 Aggregate Demand and Economic Fluctuations Macroeconomics In Context (Goodwin, et al.) Chapter Overview This chapter first introduces the analysis of business cycles, and introduces you to the

More information

Extra Problems #3. ECON 410.502 Macroeconomic Theory Spring 2010 Instructor: Guangyi Ma. Notice:

Extra Problems #3. ECON 410.502 Macroeconomic Theory Spring 2010 Instructor: Guangyi Ma. Notice: ECON 410.502 Macroeconomic Theory Spring 2010 Instructor: Guangyi Ma Extra Problems #3 Notice: (1) There are 25 multiple-choice problems covering Chapter 6, 9, 10, 11. These problems are not homework and

More information

Chapter Outline. Chapter 11. Real-Wage Rigidity. Real-Wage Rigidity

Chapter Outline. Chapter 11. Real-Wage Rigidity. Real-Wage Rigidity Chapter 11 Keynesianism: The Macroeconomics of Wage and Price Rigidity Chapter Outline Real-Wage Rigidity Price Stickiness Monetary and Fiscal Policy in the Keynesian 2008 Pearson Addison-Wesley. All rights

More information

e) Permanent changes in monetary and fiscal policies (assume now long run price flexibility)

e) Permanent changes in monetary and fiscal policies (assume now long run price flexibility) Topic I.4 concluded: Goods and Assets Markets in the Short Run a) Aggregate demand and equilibrium b) Money and asset markets equilibrium c) Short run equilibrium of Y and E d) Temporary monetary and fiscal

More information

Chapter 11 Money and Monetary Policy Macroeconomics In Context (Goodwin, et al.)

Chapter 11 Money and Monetary Policy Macroeconomics In Context (Goodwin, et al.) Chapter 11 Money and Monetary Policy Macroeconomics In Context (Goodwin, et al.) Chapter Overview In this chapter, you will be introduced to a standard treatment of the banking system and monetary policy.

More information

Problem Set #4: Aggregate Supply and Aggregate Demand Econ 100B: Intermediate Macroeconomics

Problem Set #4: Aggregate Supply and Aggregate Demand Econ 100B: Intermediate Macroeconomics roblem Set #4: Aggregate Supply and Aggregate Demand Econ 100B: Intermediate Macroeconomics 1) Explain the differences between demand-pull inflation and cost-push inflation. Demand-pull inflation results

More information

Tutor2u Economics Essay Plans Summer 2002

Tutor2u Economics Essay Plans Summer 2002 Macroeconomics Revision Essay Plan (2): Inflation and Unemployment and Economic Policy (a) Explain why it is considered important to control inflation (20 marks) (b) Discuss how a government s commitment

More information

SHORT-RUN FLUCTUATIONS. David Romer. University of California, Berkeley. First version: August 1999 This revision: January 2012

SHORT-RUN FLUCTUATIONS. David Romer. University of California, Berkeley. First version: August 1999 This revision: January 2012 SHORT-RUN FLUCTUATIONS David Romer University of California, Berkeley First version: August 1999 This revision: January 2012 Copyright 2012 by David Romer CONTENTS Preface vi I The IS-MP Model 1 I-1 Monetary

More information

Use the following to answer question 15: Exhibit: Short-run Phillips Curve. Page 3

Use the following to answer question 15: Exhibit: Short-run Phillips Curve. Page 3 Chapter 13 1. According to the sticky-price model: A) all firms announce their prices in advance. B) all firms set their prices in accord with observed prices and output. C) some firms set their prices

More information

_FALSE 1. Firms react to unplanned inventory investment by increasing output.

_FALSE 1. Firms react to unplanned inventory investment by increasing output. Macro Exam 2 Self Test -- ANSWERS Dr. McGahagan WARNING -- Be sure to take the self-test before peeking at the answers. Chapter 8 -- Aggregate Expenditure and Equilibrium Output _FALSE 1. Firms react to

More information

EC2105, Professor Laury EXAM 2, FORM A (3/13/02)

EC2105, Professor Laury EXAM 2, FORM A (3/13/02) EC2105, Professor Laury EXAM 2, FORM A (3/13/02) Print Your Name: ID Number: Multiple Choice (32 questions, 2.5 points each; 80 points total). Clearly indicate (by circling) the ONE BEST response to each

More information

1. Firms react to unplanned inventory investment by increasing output.

1. Firms react to unplanned inventory investment by increasing output. Macro Exam 2 Self Test -- T/F questions Dr. McGahagan Fill in your answer (T/F) in the blank in front of the question. If false, provide a brief explanation of why it is false, and state what is true.

More information

QUIZ 3 14.02 Principles of Macroeconomics May 19, 2005. I. True/False (30 points)

QUIZ 3 14.02 Principles of Macroeconomics May 19, 2005. I. True/False (30 points) QUIZ 3 14.02 Principles of Macroeconomics May 19, 2005 I. True/False (30 points) 1. A decrease in government spending and a real depreciation is the right policy mix to improve the trade balance without

More information

Lesson 7 - The Aggregate Expenditure Model

Lesson 7 - The Aggregate Expenditure Model Lesson 7 - The Aggregate Expenditure Model Acknowledgement: Ed Sexton and Kerry Webb were the primary authors of the material contained in this lesson. Section : The Aggregate Expenditures Model Aggregate

More information

What three main functions do they have? Reducing transaction costs, reducing financial risk, providing liquidity

What three main functions do they have? Reducing transaction costs, reducing financial risk, providing liquidity Unit 4 Test Review KEY Savings, Investment and the Financial System 1. What is a financial intermediary? Explain how each of the following fulfills that role: Financial Intermediary: Transforms funds into

More information

Finance, Saving, and Investment

Finance, Saving, and Investment 23 Finance, Saving, and Investment Learning Objectives The flows of funds through financial markets and the financial institutions Borrowing and lending decisions in financial markets Effects of government

More information

INTRODUCTION TO ADVANCED MACROECONOMICS Preliminary Exam with answers September 2014

INTRODUCTION TO ADVANCED MACROECONOMICS Preliminary Exam with answers September 2014 Duration: 120 min INTRODUCTION TO ADVANCED MACROECONOMICS Preliminary Exam with answers September 2014 Format of the mock examination Section A. Multiple Choice Questions (20 % of the total marks) Section

More information

Chapter 11: Extending the Sticky-Price Model: IS- LM, International Side, and AS-AD

Chapter 11: Extending the Sticky-Price Model: IS- LM, International Side, and AS-AD Chapter 11 1 Final Chapter 11: Extending the Sticky-Price Model: IS- LM, International Side, and AS-AD J. Bradford DeLong Questions What is money-market equilibrium? What is the LM Curve? What determines

More information

Introduction to Macroeconomics 1012 Final Exam Spring 2013 Instructor: Elsie Sawatzky

Introduction to Macroeconomics 1012 Final Exam Spring 2013 Instructor: Elsie Sawatzky Introduction to Macroeconomics 1012 Final Exam Spring 2013 Instructor: Elsie Sawatzky Name Time: 2 hours Marks: 80 Multiple choice questions 1 mark each and a choice of 2 out of 3 short answer question

More information

Final. 1. (2 pts) What is the expected effect on the real demand for money of an increase in the nominal interest rate? How to explain this effect?

Final. 1. (2 pts) What is the expected effect on the real demand for money of an increase in the nominal interest rate? How to explain this effect? Name: Number: Nova School of Business and Economics Macroeconomics, 1103-1st Semester 2013-2014 Prof. André C. Silva TAs: João Vaz, Paulo Fagandini, and Pedro Freitas Final Maximum points: 20. Time: 2h.

More information

Macroeconomics V: Aggregate Demand

Macroeconomics V: Aggregate Demand Macroeconomics V: Aggregate Demand Gavin Cameron Lady Margaret Hall Hilary Term 2004 introduction A very poor man may be said in some sense to have a demand for a coach and six; he might like to have it;

More information

Introductory Macroeconomics. Richard Povey

Introductory Macroeconomics. Richard Povey Introductory Macroeconomics Richard Povey June 3, 2007 2 Contents I The Long Run and the Classical Model 9 1 Introduction 11 1.1 What is macroeconomics?.................... 11 1.2 Key concepts and conventions..................

More information

The Short-Run Macro Model. The Short-Run Macro Model. The Short-Run Macro Model

The Short-Run Macro Model. The Short-Run Macro Model. The Short-Run Macro Model The Short-Run Macro Model In the short run, spending depends on income, and income depends on spending. The Short-Run Macro Model Short-Run Macro Model A macroeconomic model that explains how changes in

More information

CHAPTER 5 Review... Page 1

CHAPTER 5 Review... Page 1 CHAPTER 5 Review... 1. The rate of inflation is the: A) median level of prices. B) average level of prices. C) percentage change in the level of prices. D) measure of the overall level of prices. 2. If

More information

I. Introduction to Aggregate Demand/Aggregate Supply Model

I. Introduction to Aggregate Demand/Aggregate Supply Model University of California-Davis Economics 1B-Intro to Macro Handout 8 TA: Jason Lee Email: jawlee@ucdavis.edu I. Introduction to Aggregate Demand/Aggregate Supply Model In this chapter we develop a model

More information

Economics 101 Multiple Choice Questions for Final Examination Miller

Economics 101 Multiple Choice Questions for Final Examination Miller Economics 101 Multiple Choice Questions for Final Examination Miller PLEASE DO NOT WRITE ON THIS EXAMINATION FORM. 1. Which of the following statements is correct? a. Real GDP is the total market value

More information

Problem Set for Chapter 20(Multiple choices)

Problem Set for Chapter 20(Multiple choices) Problem Set for hapter 20(Multiple choices) 1. According to the theory of liquidity preference, a. if the interest rate is below the equilibrium level, then the quantity of money people want to hold is

More information

LECTURE NOTES ON MACROECONOMIC PRINCIPLES

LECTURE NOTES ON MACROECONOMIC PRINCIPLES LECTURE NOTES ON MACROECONOMIC PRINCIPLES Peter Ireland Department of Economics Boston College peter.ireland@bc.edu http://www2.bc.edu/peter-ireland/ec132.html Copyright (c) 2013 by Peter Ireland. Redistribution

More information

3. a. If all money is held as currency, then the money supply is equal to the monetary base. The money supply will be $1,000.

3. a. If all money is held as currency, then the money supply is equal to the monetary base. The money supply will be $1,000. Macroeconomics ECON 2204 Prof. Murphy Problem Set 2 Answers Chapter 4 #2, 3, 4, 5, 6, 7, and 9 (on pages 102-103) 2. a. When the Fed buys bonds, the dollars that it pays to the public for the bonds increase

More information

Money and Public Finance

Money and Public Finance Money and Public Finance By Mr. Letlet August 1 In this anxious market environment, people lose their rationality with some even spreading false information to create trading opportunities. The tales about

More information