Chapter 26. An Aggregate Supply and Demand Perspective on Money and Economic Stability. Learning Objectives. Introduction

Save this PDF as:
 WORD  PNG  TXT  JPG

Size: px
Start display at page:

Download "Chapter 26. An Aggregate Supply and Demand Perspective on Money and Economic Stability. Learning Objectives. Introduction"

Transcription

1 Chapter 26 An Aggregate Supply and Demand Perspective on Money and Economic Stability Learning Objectives Analyze the debate centering on the stability of the economy around its full employment level Define the role crowding out has in debates between Keynesian and monetarists Explain the Phillips curve and its relevance for fiscal and monetary policy Understand the importance of real versus nominal interest rates in the discussion of monetary policy 26-2 Introduction The importance of money in explaining aggregate economic outcomes is a defining distinction between classical and Keynesian economists Monetarists group of economists who uphold the classical tradition of nonintervention and believe that money supply should not be a focus of government policy as a tool of economic stability

2 Introduction (Cont.) New Classical Macroeconomists refining Monetarists thinking by focusing on rational expectations The important elements of the Monetarists-Keynesian debate can be articulated within the aggregate supply and demand framework Stability of the economy Relative effectiveness of monetary/fiscal policy The causes of inflation Consequences for interest rates 26-4 Stable? Monetarists tend to believe that aggregate demand will be relatively unaffected by autonomous shifts in investment spending Keynes felt active attempts at stabilization were necessary to counter entrepreneurial animal spirits 26-5 Monetarists Exogenous decrease in investment spending will be automatically countered by increased consumption or interest-sensitive investment With fixed money stock, quantity theory suggests aggregate demand will be relatively stable Downward shift in investment functions would lower interest rates, stimulating investment spending and reducing savings which would offset the drop in investment

3 Monetarists (Cont.) Fluctuations in the price level are another source of stability Fixed money stock with lower prices would mean a larger real supply of money which would stimulate spending Larger real supply of money would lower interest rates and investment spending would increase still further 26-7 Keynesians The quantity theory linkage between money and aggregate demand is not a reality Interest rates do not necessarily decline following a drop in investment Even if interest rates do decline, no guarantee that it would induce very much additional spending Keynesian response to falling prices suggested by classical economists is twofold: Prices rarely decline Spending effects react too slow to restore full employment 26-8 Figure 26.1 Monetarists response to declines in exogenous investment Downward sloping demand curve Vertical supply curve reflecting the classical assumption that quantity supplied is fixed at full employment Y FE Slope of the aggregate demand curve Monetarists Quantity theory assumes a direct impact of increased real money balances on the demand for output More real money balance, increased spending

4 FIGURE 26.1 Monetarist response to declines in exogenous investment: Income remains at the full employment level Figure 26.1 (Cont.) Slope of the aggregate demand curve (Cont.) Keynesians Many things can intervene between real money balances and demand Interest rates may not fall very much since people may simply hold the additional cash balances Direct spending may not be responsive to decreases in interest rate This suggests slope of aggregate demand curve is flatter for Monetarists than for Keynesians changes in quantity demanded are more responsive to changes in price Figure 26.1 (Cont.) Stability of the aggregate demand curve Does it move in response to a decline in investment Monetarists Stock of money is the major factor in determining aggregate demand With a fixed money supply, there is relatively little movement of the aggregate demand schedule following exogenous shifts in spending Keynesians Aggregate demand schedule will be pushed to the left if exogenous investment falls At every price level fewer goods are demanded

5 Economic Stability Depends on behavior of the aggregate demand schedule and shape of aggregate supply curve Monetarists approach Figure 26.1 vertical aggregate supply at full employment Aggregate demand curve may not shift with reduction in investment, but remain stable at D, with Y FE and P Economic Stability (Cont.) Monetarists approach (Cont.) However, if the aggregate demand curve does shift from D to D, the following adjustment will occur Resulting unemployment will cause prices to fall toward P With reduced prices, real quantity of money increases This causes aggregate demand to increase along D Equilibrium is restored at lower prices, P, and economy back at full employment, Y FE Economic Stability (Cont.) Keynesian approach Figure 26.2 Two cases: 1) horizontal supply curve (S) and 2) upward sloping supply curve (S ) Assume aggregate demand decreases from D to D Short run adjustment (horizontal aggregate supply [S]) Prices are rigid at P and do not fall Economy moves to income level, Y, which represents unemployment and excess capacity No automatic adjustment through falling prices

6 FIGURE 26.2 Keynesian response to declines in exogenous investment: Income falls below full employment level Economic Stability (Cont.) Keynesian approach (Cont.) More realistic adjustment (upward sloping aggregate supply [S ]) Prices and wages will eventually decline, but at a slow pace The economy will reach equilibrium at P, and Y, which is below full employment income level The adjustment will result in a higher income level than in the case where prices do not decline Wages and prices do not fall sufficiently to stimulate aggregate demand along D to offset the decrease in exogenous investment Economic Stability (Cont.) Keynesian approach (Cont.) Both S and S in the Keynesian adjustment represent short run outcomes With continued unemployment, there will be an ongoing downward pressure on wages and incentives for producers to move back to full employment The Keynesians acknowledge the vertical aggregate supply as the eventual long run outcome However, this final adjustment can take a long time supporting the Keynesian reliance on monetary and fiscal policy to stimulate the economy

7 Monetary Policy, Fiscal Policy, and Crowding Out With upward sloping aggregate supply curve (Figure 26.2) and a lengthy adjustment period, monetary and fiscal policies are an option to government policymakers Monetarist approach to monetary policy Increasing the money supply will push the aggregate demand curve to the right The transmission mechanism of the increase in money supply is direct more money means more spending on goods and services Monetary Policy, Fiscal Policy, and Crowding Out (Cont.) Keynesian approach to monetary policy Increased money supply may shift the aggregate demand to the right, but the impact is less certain Purchases of bonds with extra cash balances will push up prices and reduce interest rates: Cost-of-capital effect increased investment spending Wealth effect higher bond prices increases consumer wealth which is translated into more spending Exchange rate effect lower interest rates drives down the value of the dollar, increasing spending on net exports Credit availability effect lower interest rates means more borrowing and spending Monetary Policy, Fiscal Policy, and Crowding Out (Cont.) With the tenuous linkage of monetary policy, Keynesians focus on fiscal policy Offset decrease of spending by increasing government spending or lowering taxes Crowding out effect Monetarists argue increased government spending will increase interest rates Higher interest rates may inhibit private investment spending that offsets increased government spending and have little, if any, effect on aggregate demand

8 Monetary Policy, Fiscal Policy, and Crowding Out (Cont.) Crowding out effect (Cont.) Government fiscal policy merely changes the proportion of government spending relative to private spending Therefore, in the Monetarist world, execution and net impact of fiscal has definite monetary implications Monetary Policy, Fiscal Policy, and Crowding Out (Cont.) Crowding out effect (Cont.) While Keynes acknowledged this increase in interest rates, there is an issue of how the increased government spending is financed Financing by money creation is more expansionary than financing by bond sales Both money creation and bond sales are more expansionary than financing by increased taxation Higher interest rates has a dual effect Reducing investment spending, People economize on cash balances which supplies part of the additional money needed for higher transactions Inflation, Money, and the Phillips Curve Previous discussion questions effectiveness of countercyclical government policy Expansion of money supply to stimulate economy may be anticipated and lead to inflation rather than increased spending Debate between Keynesians and Monetarists depends on whether or not inflation is purely a monetary phenomenon, which revolves around influences on the aggregate demand

9 Inflation, Money, and the Phillips Curve (Cont.) Figure 26.3 Vertical aggregate supply curve at full employment, Y FE Monetarists The aggregate demand schedule is stable at D, unless the money supply increases due to action by the Federal Reserve This will cause a shift to D and D, which increases prices from P to P and P The persistent increase of prices through expanding money supply results in inflation FIGURE 26.3 Anything shifting aggregate demand to the right causes inflation Inflation, Money, and the Phillips Curve (Cont.) Figure 26.3 (Cont.) Keynesians Increase in spending by any group can cause the aggregate demand curve to shift Any ill-timed government policy, fiscal or monetary, with the economy at full employment can cause inflation Therefore, Monetarists view inflation as a direct result of expansion of money supply by Federal Reserve, whereas Keynesians do not restrict causes of inflation to monetary policy

10 Inflation, Money, and the Phillips Curve (Cont.) Cost-push inflation Can be a result of a leftward shift of the aggregate supply curve caused by a supply shock Monetarists argue that such a shock is a once-andfor-all phenomenon (energy crisis of the 1970s) and cannot account for persistent inflation Inflation, Money, and the Phillips Curve (Cont.) Another issue dividing Monetarists and Keynesians concerns the possibility of a tradeoff between inflation and unemployment Monetarists Deny the possibility of a trade-off and argue that once inflation is incorporated into people s expectations, the unemployment will revert to its natural level Figure 26.3 is the Monetarists approach a vertical supply curve with no change in GDP just increased prices Inflation, Money, and the Phillips Curve (Cont.) Keynesians Figure 26.a1 Support the idea of a trade-off known as the Phillips Curve lower rates of unemployment can be achieved with higher rates of inflation Figure 26.4 presents the Keynesian view an upward sloping supply curve showing that as prices rise, real output expands beyond Y FE with a lower unemployment rate

11 The graph of a Phillips curve looks like this FIGURE 26.4 Inflation causes higher income (and lower unemployment) with a positively sloped supply curve Inflation, Money, and the Phillips Curve (Cont.) Keynesian rational for an upward sloping aggregate supply curve Output varies positively with prices only when wages change more slowly than prices This is a reasonable assumption because many wage rates are set contractually, and contracts are not adjusted continuously When this occurs, labor s real compensation falls, more workers are hired and GDP rises This provides the rationale for the trade-off between inflation and unemployment

12 Inflation, Money, and the Phillips Curve (Cont.) Monetarists long-run adjustment Eventually inflation reality sets in and workers expect a continued higher level of price increases and push for wage demands in line with inflation When this occurs, employers no longer find it profitable to retain the high levels of output and the economy reverts to full employment, Y FE Once these adjustments have been made, the aggregate supply curve becomes vertical and there is no long-run trade-off Inflation and Interest Rates Inflationary expectations are crucial to explaining how interest rates respond to changes in the money supply The Keynesian view is that increasing the money supply will lower the interest rate Monetarists argue that, in the long-run, an expansionary monetary policy raises interest rates, direct opposite to Keynesian view Inflation and Interest Rates (Cont.) Monetarist Argument Increase in money supply may initially lower interest rates resulting from purchases of financial assets Once aggregate demand responds to the increase in money supply, the transaction demand for money will increase which pushes up the interest rate Expectations of inflation generated by an expansionary monetary policy will cause a further increase in the level of nominal interest rates the inflation premium

13 Inflation and Interest Rates (Cont.) Monetarist Argument (Cont.) However it may take time for the inflation premium to be fully reflected in nominal rates, resulting in a decline in the real interest rate Therefore, if expansionary efforts by the Federal Reserve to lower interest rates are fully anticipated, the result may be higher prices and increased nominal interest rates Should a Robot Replace the Federal Reserve? If self-correcting mechanisms work properly, no need for government monetary or fiscal action to stabilize the economy Keynes maintained that these stabilizing forces were uncertain which prompted the need for countercyclical monetary and fiscal policies However, it is possible that attempts at countercyclical policies can cause greater instability Should a Robot Replace the Federal Reserve? (Cont.) Milton Friedman, influential Monetarist, recognized the importance of dealing with lags in the economy and how these could create instability Figure 26.5 It is possible that attempts to stimulate the economy may take effect after economy has made self-corrections and is starting to expand In this case the stimulus effect occurs at precisely the wrong time in the cycle, causing wider fluctuations that would have occurred if left alone

14 FIGURE 26.5 Friedman s alleged perverse effects of countercyclical monetary policy Should a Robot Replace the Federal Reserve? (Cont.) Monetarists Fixed Rule Policy Based on the inherent destabilizing lags, Monetarists have discarded the idea of using orthodox monetary policy They have concluded that the best stabilization policy is no stabilization policy at all Instead, they advocate a fixed long-run rule increase the money supply at a steady and inflexible rate regardless of current economic conditions Should a Robot Replace the Federal Reserve? (Cont.) Monetarists Fixed Rule Policy (Cont.) Figure 26.6 If the growth rate of money is properly selected there should be balanced growth between aggregate demand and aggregate supply Real economic growth Stable prices High employment The main advantage of this rule is to eliminate forecasting and lag problems and remove the instability of destabilizing discretionary countercyclical monetary policy

15 FIGURE 26.6 Aggregate demand and supply shifting together over time according to a fixed monetary rule Should a Robot Replace the Federal Reserve? (Cont.) Monetarists Fixed Rule Policy (Cont.) In March 1975, Congress mandated the Federal Reserve to maintain long-run growth of the monetary and credit aggregates commensurate with the economy s long-run potential to increase production In November 1977, this provision was incorporated into the Federal Reserve Act This mandate has forced the Federal Reserve to assess its policies and achieve a smoother monetary growth Should a Robot Replace the Federal Reserve? (Cont.) Interesting conclusion of this chapter Extremists from both the Keynesian and Monetarist schools have collectively ganged up on the Federal Reserve Suggest that a very limited role of the Fed in achieving economic stability is the appropriate action

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 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

Aggregate Supply and Aggregate Demand

Aggregate Supply and Aggregate Demand 26 Aggregate Supply and Aggregate Demand Learning Objectives Explain what determines aggregate supply Explain what determines aggregate demand Explain what determines real GDP and the price level and how

More information

7 AGGREGATE SUPPLY AND AGGREGATE DEMAND* Chapter. Key Concepts

7 AGGREGATE SUPPLY AND AGGREGATE DEMAND* Chapter. Key Concepts Chapter 7 AGGREGATE SUPPLY AND AGGREGATE DEMAND* Key Concepts Aggregate Supply The aggregate production function shows that the quantity of real GDP (Y ) supplied depends on the quantity of labor (L ),

More information

Answers. Event: a tax cut 1. affects C, AD curve 2. shifts AD right 3. SR eq m at point B. P and Y higher, unemp lower 4.

Answers. Event: a tax cut 1. affects C, AD curve 2. shifts AD right 3. SR eq m at point B. P and Y higher, unemp lower 4. A C T I V E L E A R N I N G 2: Answers Event: a tax cut 1. affects C, AD curve 2. shifts AD right 3. SR eq m at point B. P and Y higher, unemp lower 4. Over time, P E rises, SRAS shifts left, until LR

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

Using Policy to Stabilize the Economy

Using Policy to Stabilize the Economy Using Policy to Stabilize the Economy Since the Employment ct of 1946, economic stabilization has been a goal of U.S. policy. Economists debate how active a role the govt should take to stabilize the economy.

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

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

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

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

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

Chapter 22. The Classical Foundations. Learning Objectives. Introduction

Chapter 22. The Classical Foundations. Learning Objectives. Introduction Chapter 22 The Classical Foundations Learning Objectives Define Say s law and the classical understanding of aggregate supply Understand the supply of saving and demand for investment that leads to the

More information

Suggested Answers for Mankiw Questions for Review & Problems

Suggested Answers for Mankiw Questions for Review & Problems Suggested Answers for Mankiw & Problems The answers here will not have graphs, I encourage to refer to the text for graphs. There is a some math, however I don t expect you to replicate these in your exam,

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

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

Introduction to The IS-LM Model

Introduction to The IS-LM Model Chapter 9 The IS-LM/AD-AS Model: A General Framework for Macroeconomic Analysis Economics 282 University of Alberta Introduction to The IS-LM Model This name originates from its basic equilibrium conditions:

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

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

Chapter 18. MODERN PRINCIPLES OF ECONOMICS Third Edition

Chapter 18. MODERN PRINCIPLES OF ECONOMICS Third Edition Chapter 18 MODERN PRINCIPLES OF ECONOMICS Third Edition Fiscal Policy Outline Fiscal Policy: The Best Case The Limits to Fiscal Policy When Fiscal Policy Might Make Matters Worse So When Is Fiscal Policy

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

4 Macroeconomics LESSON 6

4 Macroeconomics LESSON 6 4 Macroeconomics LESSON 6 Interest Rates and Monetary Policy in the Short Run and the Long Run Introduction and Description This lesson explores the relationship between the nominal interest rate and the

More information

chapter: Aggregate Demand and Aggregate Supply Krugman/Wells 2009 Worth Publishers 1 of 58

chapter: Aggregate Demand and Aggregate Supply Krugman/Wells 2009 Worth Publishers 1 of 58 chapter: 12 >> Aggregate Demand and Aggregate Supply Krugman/Wells 2009 Worth Publishers 1 of 58 WHAT YOU WILL LEARN IN THIS CHAPTER How the aggregate demand curve illustrates the relationship between

More information

The Fiscal Policy and The Monetary Policy. Ing. Mansoor Maitah Ph.D.

The Fiscal Policy and The Monetary Policy. Ing. Mansoor Maitah Ph.D. The Fiscal Policy and The Monetary Policy Ing. Mansoor Maitah Ph.D. Government in the Economy The Government and Fiscal Policy Fiscal Policy changes in taxes and spending that affect the level of GDP to

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

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

Effects of Inflation Unanticipated Inflation in the Labor Market

Effects of Inflation Unanticipated Inflation in the Labor Market Effects of Inflation Unanticipated Inflation in the Labor Market Unanticipated inflation has two main consequences in the labor market: Redistribution of income Departure from full employment Effects of

More information

Agenda. Business Cycles. What Is a Business Cycle? What Is a Business Cycle? What is a Business Cycle? Business Cycle Facts.

Agenda. Business Cycles. What Is a Business Cycle? What Is a Business Cycle? What is a Business Cycle? Business Cycle Facts. Agenda What is a Business Cycle? Business Cycles.. 11-1 11-2 Business cycles are the short-run fluctuations in aggregate economic activity around its long-run growth path. Y Time 11-3 11-4 1 Components

More information

Agenda. The IS-LM/AD-AS Model: A General Framework for Macroeconomic Analysis, Part 3. Disequilibrium in the AD-AS model

Agenda. The IS-LM/AD-AS Model: A General Framework for Macroeconomic Analysis, Part 3. Disequilibrium in the AD-AS model Agenda The IS-LM/AD-AS Model: A General Framework for Macroeconomic Analysis, art 3 rice Adjustment and the Attainment of General Equilibrium 13-1 13-2 General equilibrium in the AD-AS model Disequilibrium

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

CH 10 - REVIEW QUESTIONS

CH 10 - REVIEW QUESTIONS CH 10 - REVIEW QUESTIONS 1. The short-run aggregate supply curve is horizontal at: A) a level of output determined by aggregate demand. B) the natural level of output. C) the level of output at which the

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

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

Pre-Test Chapter 15 ed17

Pre-Test Chapter 15 ed17 Pre-Test Chapter 15 ed17 Multiple Choice Questions 1. The extended AD-AS model: A. distinguishes between short-run and long-run aggregate demand. B. explains inflation but not recession. C. includes G

More information

THE ECONOMY AT FULL EMPLOYMENT: THE CLASSICAL MODEL*

THE ECONOMY AT FULL EMPLOYMENT: THE CLASSICAL MODEL* Chapter 8 THE ECONOMY AT FULL EMPLOYMENT: THE CLASSICAL MODEL* The Classical Model: A Preview Topic: Real Variables 1) Real variables A) are those that determine the cost of living. B) are those that determine

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

Inflation and Unemployment CHAPTER 22 THE SHORT-RUN TRADE-OFF 0

Inflation and Unemployment CHAPTER 22 THE SHORT-RUN TRADE-OFF 0 22 The Short-Run Trade-off Between Inflation and Unemployment CHAPTER 22 THE SHORT-RUN TRADE-OFF 0 In this chapter, look for the answers to these questions: How are inflation and unemployment related in

More information

Chapter 20. Short-Run Economic Fluctuations KEY FACTS ABOUT ECONOMIC FLUCTUATIONS

Chapter 20. Short-Run Economic Fluctuations KEY FACTS ABOUT ECONOMIC FLUCTUATIONS Chapter 2 urpose of Chapter 2: Develop a model that economists use to analyze the economy s short-run fluctuations - the model of demand and. Short-Run Economic Fluctuations Economic activity fluctuates

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

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 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

With lectures 1-8 behind us, we now have the tools to support the discussion and implementation of economic policy.

With lectures 1-8 behind us, we now have the tools to support the discussion and implementation of economic policy. The Digital Economist Lecture 9 -- Economic Policy With lectures 1-8 behind us, we now have the tools to support the discussion and implementation of economic policy. There is still great debate about

More information

Economics 152 Solution to Sample Midterm 2

Economics 152 Solution to Sample Midterm 2 Economics 152 Solution to Sample Midterm 2 N. Das PART 1 (84 POINTS): Answer the following 28 multiple choice questions on the scan sheet. Each question is worth 3 points. 1. If Congress passes legislation

More information

Answers to Text Questions and Problems in Chapter 11

Answers to Text Questions and Problems in Chapter 11 Answers to Text Questions and Problems in Chapter 11 Answers to Review Questions 1. The aggregate demand curve relates aggregate demand (equal to short-run equilibrium output) to inflation. As inflation

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

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

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

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

Pre-Test Chapter 10 ed17

Pre-Test Chapter 10 ed17 Pre-Test Chapter 10 ed17 Multiple Choice Questions 1. Refer to the above diagrams. Assuming a constant price level, an increase in aggregate expenditures from AE 1 to AE 2 would: A. move the economy from

More information

Chapter 12: Gross Domestic Product and Growth Section 1

Chapter 12: Gross Domestic Product and Growth Section 1 Chapter 12: Gross Domestic Product and Growth Section 1 Key Terms national income accounting: a system economists use to collect and organize macroeconomic statistics on production, income, investment,

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

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

The Circular Flow of Income and Expenditure

The Circular Flow of Income and Expenditure The Circular Flow of Income and Expenditure Imports HOUSEHOLDS Savings Taxation Govt Exp OTHER ECONOMIES GOVERNMENT FINANCIAL INSTITUTIONS Factor Incomes Taxation Govt Exp Consumer Exp Exports FIRMS Capital

More information

Aggregate Demand and Aggregate Supply Ing. Mansoor Maitah Ph.D. et Ph.D.

Aggregate Demand and Aggregate Supply Ing. Mansoor Maitah Ph.D. et Ph.D. Aggregate Demand and Aggregate Supply Ing. Mansoor Maitah Ph.D. et Ph.D. Aggregate Demand and Aggregate Supply Economic fluctuations, also called business cycles, are movements of GDP away from potential

More information

Instructions: Please answer all of the following questions. You are encouraged to work with one another (at your discretion).

Instructions: Please answer all of the following questions. You are encouraged to work with one another (at your discretion). Instructions: Please answer all of the following questions. You are encouraged to work with one another (at your discretion). 1. What are the similarities and differences between the characteristics of

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

Name: Final Exam Econ 219 Spring You can skip one multiple choice question. Indicate clearly which one

Name: Final Exam Econ 219 Spring You can skip one multiple choice question. Indicate clearly which one Name: Final Exam Econ 219 Spring 2005 This is a closed book exam. You are required to abide all the rules of the Student Conduct Code of the University of Connecticut. You can skip one multiple choice

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

7 AGGREGATE SUPPLY AND AGGREGATE DEMAND* * Chapter Key Ideas. Outline

7 AGGREGATE SUPPLY AND AGGREGATE DEMAND* * Chapter Key Ideas. Outline C h a p t e r 7 AGGREGATE SUPPLY AND AGGREGATE DEMAND* * Chapter Key Ideas Outline Production and Prices A. What forces bring persistent and rapid expansion of real GDP? B. What leads to inflation? 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

Note: This feature provides supplementary analysis for the material in Part 3 of Common Sense Economics.

Note: This feature provides supplementary analysis for the material in Part 3 of Common Sense Economics. 1 Module C: Fiscal Policy and Budget Deficits Note: This feature provides supplementary analysis for the material in Part 3 of Common Sense Economics. Fiscal and monetary policies are the two major tools

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

I. MULTIPLE CHOICES. Choose the one alternative that best completes the statement to answer the question.

I. MULTIPLE CHOICES. Choose the one alternative that best completes the statement to answer the question. Econ 20B- Additional Problem Set I. MULTIPLE CHOICES. Choose the one alternative that best completes the statement to answer the question. 1. Which of the following is correct? a. Over the business cycle

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

2.5 Monetary policy: Interest rates

2.5 Monetary policy: Interest rates 2.5 Monetary policy: Interest rates Learning Outcomes Describe the role of central banks as regulators of commercial banks and bankers to governments. Explain that central banks are usually made responsible

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

MONEY, INTEREST, REAL GDP, AND THE PRICE LEVEL*

MONEY, INTEREST, REAL GDP, AND THE PRICE LEVEL* Chapter 11 MONEY, INTEREST, REAL GDP, AND THE PRICE LEVEL* The Demand for Topic: Influences on Holding 1) The quantity of money that people choose to hold depends on which of the following? I. The price

More information

Economic Systems. 1. MARKET ECONOMY in comparison to 2. PLANNED ECONOMY

Economic Systems. 1. MARKET ECONOMY in comparison to 2. PLANNED ECONOMY Economic Systems The way a country s resources are owned and the way that country takes decisions as to what to produce, how much to produce and how to distribute what has been produced determine the type

More information

Macroeconomics Series 2: Money Demand, Money Supply and Quantity Theory of Money

Macroeconomics Series 2: Money Demand, Money Supply and Quantity Theory of Money Macroeconomics Series 2: Money Demand, Money Supply and Quantity Theory of Money by Dr. Charles Kwong School of Arts and Social Sciences The Open University of Hong Kong 1 Lecture Outline 2. Determination

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

Macroeconomics VIII: Equilibrium of Aggregate Supply and Demand

Macroeconomics VIII: Equilibrium of Aggregate Supply and Demand Macroeconomics VIII: Equilibrium of Aggregate Supply and Demand Gavin Cameron Lady Margaret Hall Hilary Term 2004 aggregate demand revisited Aggregate demand comprises four components: consumption investment

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

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

Long run v.s. short run. Introduction. Aggregate Demand and Aggregate Supply. In this chapter, look for the answers to these questions:

Long run v.s. short run. Introduction. Aggregate Demand and Aggregate Supply. In this chapter, look for the answers to these questions: 33 Aggregate Demand and Aggregate Supply R I N C I L E S O F ECONOMICS FOURTH EDITION N. GREGOR MANKIW Long run v.s. short run Long run growth: what determines long-run output (and the related employment

More information

Chapter 12. Unemployment and Inflation. 2008 Pearson Addison-Wesley. All rights reserved

Chapter 12. Unemployment and Inflation. 2008 Pearson Addison-Wesley. All rights reserved Chapter 12 Unemployment and Inflation Chapter Outline Unemployment and Inflation: Is There a Trade-Off? The Problem of Unemployment The Problem of Inflation 12-2 Unemployment and Inflation: Is There a

More information

MONEY, INTEREST, REAL GDP, AND THE PRICE LEVEL*

MONEY, INTEREST, REAL GDP, AND THE PRICE LEVEL* Chapter 11 MONEY, INTEREST, REAL GDP, AND THE PRICE LEVEL* Key Concepts The Demand for Money Four factors influence the demand for money: The price level An increase in the price level increases the nominal

More information

THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONS

THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONS 15 In this chapter, look for the answers to these questions: What are economic fluctuations? What are their characteristics? How does the model of demand and explain economic fluctuations? Why does the

More information

1. Explain what causes the liquidity preference money (LM) curve to shift and why.

1. Explain what causes the liquidity preference money (LM) curve to shift and why. Chapter 22. IS-LM in Action C H A P T E R O B J E C T I V E S By the end of this chapter, students should be able to: 1. Explain what causes the liquidity preference money (LM) curve to shift and why.

More information

AP Macroeconomics. Practice Exam. Advanced Placement Program

AP Macroeconomics. Practice Exam. Advanced Placement Program Advanced Placement Program AP Macroeconomics Practice Exam The questions contained in this AP Macroeconomics Practice Exam are written to the content specifications of AP Exams for this subject. Taking

More information

Objectives for Chapter 9 Aggregate Demand and Aggregate Supply

Objectives for Chapter 9 Aggregate Demand and Aggregate Supply 1 Objectives for Chapter 9 Aggregate Demand and Aggregate Supply At the end of Chapter 9, you will be able to answer the following: 1. Explain what is meant by aggregate demand? 2. Name the four categories

More information

1. Fill in the blanks for the following sentence: A rise in taxes on households will shift AD to the, this will push.

1. Fill in the blanks for the following sentence: A rise in taxes on households will shift AD to the, this will push. Homework 16 1. Fill in the blanks for the following sentence: A rise in taxes on households will shift AD to the, this will push. A. right; down B. left; down C. left; up D. right; up 2. During a recession,

More information

SRAS. is less than Y P

SRAS. is less than Y P KrugmanMacro_SM_Ch12.qxp 11/15/05 3:18 PM Page 141 Fiscal Policy 1. The accompanying diagram shows the current macroeconomic situation for the economy of Albernia. You have been hired as an economic consultant

More information

Refer to Figure 17-1

Refer to Figure 17-1 Chapter 17 1. Inflation can be measured by the a. change in the consumer price index. b. percentage change in the consumer price index. c. percentage change in the price of a specific commodity. d. change

More information

Chapter 7: Classical-Keynesian Controversy John Petroff

Chapter 7: Classical-Keynesian Controversy John Petroff Chapter 7: Classical-Keynesian Controversy John Petroff The purpose of this topic is show two alternative views of the business cycle and the major problems of unemployment and inflation. The classical

More information

CHAPTER 11. AN OVEVIEW OF THE BANK OF ENGLAND QUARTERLY MODEL OF THE (BEQM)

CHAPTER 11. AN OVEVIEW OF THE BANK OF ENGLAND QUARTERLY MODEL OF THE (BEQM) 1 CHAPTER 11. AN OVEVIEW OF THE BANK OF ENGLAND QUARTERLY MODEL OF THE (BEQM) This model is the main tool in the suite of models employed by the staff and the Monetary Policy Committee (MPC) in the construction

More information

Supplemental Unit 5: Fiscal Policy and Budget Deficits

Supplemental Unit 5: Fiscal Policy and Budget Deficits 1 Supplemental Unit 5: Fiscal Policy and Budget Deficits Fiscal and monetary policies are the two major tools available to policy makers to alter total demand, output, and employment. This feature will

More information

MACROECONOMICS SECTION

MACROECONOMICS SECTION MACROECONOMICS SECTION GENERAL TIPS Be sure every graph is carefully labeled and explained. Every answer must include a section that contains a response to WHY the result holds. Good resources include

More information

Econ 202 H01 Final Exam Spring 2005

Econ 202 H01 Final Exam Spring 2005 Econ202Final Spring 2005 1 Econ 202 H01 Final Exam Spring 2005 1. Which of the following tends to reduce the size of a shift in aggregate demand? a. the multiplier effect b. the crowding-out effect c.

More information

Lesson 8 - Aggregate Demand and Aggregate Supply

Lesson 8 - Aggregate Demand and Aggregate Supply Lesson 8 - Aggregate Demand and Aggregate Supply Acknowledgement: Ed Sexton and Kerry Webb were the primary authors of the material contained in this lesson. Section 1: Aggregate Demand The second macroeconomic

More information

1) Explain why each of the following statements is true. Discuss the impact of monetary and fiscal policy in each of these special cases:

1) Explain why each of the following statements is true. Discuss the impact of monetary and fiscal policy in each of these special cases: 1) Explain why each of the following statements is true. Discuss the impact of monetary and fiscal policy in each of these special cases: a) If investment does not depend on the interest rate, the IS curve

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

Thinkwell s Homeschool Economics Course Lesson Plan: 36 weeks

Thinkwell s Homeschool Economics Course Lesson Plan: 36 weeks Thinkwell s Homeschool Economics Course Lesson Plan: 36 weeks Welcome to Thinkwell s Homeschool Economics! We re thrilled that you ve decided to make us part of your homeschool curriculum. This lesson

More information

In the news. The Global Economy Aggregate Supply & Demand. Roadmap. In the news. In the news. In the news

In the news. The Global Economy Aggregate Supply & Demand. Roadmap. In the news. In the news. In the news In the news 50% 45% The Global Economy ggregate Supply & Demand Top 10% Income Share 40% 35% 30% Including capital gains Excluding capital gains 25% 1917 1922 1927 1932 1937 1942 1947 1952 1957 1962 1967

More information

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

Assignment #3. ECON 410.502 Macroeconomic Theory Spring 2010 Instructor: Guangyi Ma. Notice: ECON 410.502 Macroeconomic Theory Spring 2010 Instructor: Guangyi Ma Assignment #3 Notice: (1) There are 25 multiple-choice problems and 2 analytic (short-answer) problems. This assignment is due on March

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

2 0 0 0 E D I T I O N CLEP O F F I C I A L S T U D Y G U I D E. The College Board. College Level Examination Program

2 0 0 0 E D I T I O N CLEP O F F I C I A L S T U D Y G U I D E. The College Board. College Level Examination Program 2 0 0 0 E D I T I O N CLEP O F F I C I A L S T U D Y G U I D E College Level Examination Program The College Board Principles of Macroeconomics Description of the Examination The Subject Examination in

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

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

x = %ΔX = rate of change of spending m = %ΔM = rate of change of the money supply v = %ΔV = rate of change of the velocity of money

x = %ΔX = rate of change of spending m = %ΔM = rate of change of the money supply v = %ΔV = rate of change of the velocity of money SECTION E. THE CREDIT MARKET EQUATION: is: x = m + v addresses the question: o What are the causes of changes of spending? o How is it possible for spending to change? o What must happen in order for spending

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