Name Date Per. Unit 4: Money, Banking, and Monetary Policy Classical v. Keynesian Economics

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1 Name Date Per Unit 4: Money, Banking, and Monetary Policy Classical v. Keynesian Economics 1. Classical Theory- A change in AD will not change because prices are flexible. AS is vertical so AD can t increase without causing. a. Graph 1: b. Graph 2: 2. Keynesian Theory- A decrease in AD will lead to a because prices of resources (wages) are NOT _-. An increase in AD during a recession doesn t cause inflation. a. Graph 1: b. Graph 2: 3. 3 Ranges of Aggregate Supply a. Keynesian Rangeb. Intermediate Rangec. Classical Range Money 1. Why do we use money? a. Barter system: b. Issues:

2 2. What is Money? a. Money is anything that is generally accepted in b. Money is NOT the same as c. Commodity Money: - Something that performs the function of money and has. Examples: d. Fiat Money- based on. Serves as money but has Examples: 3. 3 Functions of Money: a. Medium of Exchange: b. Unit of Account: c. Store of Value: 4. What backs the money supply? 5. What makes money effective? The purchasing power of money is. (Inflation purchasing power, rapid inflation acceptability) 6. How do we classify money? a. Liquidity: b. M1 (highest liquidity): c. M2 (Near-Moneys): 7. The Financial Sector: a. Individuals, businesses, and governments borrow and save, so they need institutions to help. The financial sector is Assets- anything tangible or intangible that is owned. Liabilities. Loan: Usually at a fee called the. A loan is an for the lender and for the borrower. 8. Bonds v. Stocks a. Bonds are The bond holder has b. Stocks- represents ownership of a and are entitled to a portion of the profits. Bond price and are. 9. Time Value of Money: Would you rather have $100 today or $200 in the future? a. You can determine the future value of any amount ( ) if you know the interest rate ( ) and the number of years ( ) b. Equation for Future Value: c. Equation for Present Value:

3 Money Market 1. The Demand for Money: At any given time, people demand a certain amount of liquid assets( ) for two different reasons: a. Transaction demand: b. Asset Demand: c. What is the opportunity cost of hold keeping money in your pocket or checking account? d. What happens to the quantity demanded of money when interest rates increase? What happens to the quantity demanded when interest rates decrease? There is an relationship between the IR and the quantity of money demanded. e. Graph f. What happens if the price levels increase? Three things shift Money Demand (draw graph to the right of shifters) i. Changes in ii. Changes in iii. Changes in g. The U.S. money supply is set by the also known as the Fed. The Fed is a government office that sets and adjusts the money supply to. This is called. The Fed was created in 1913, to regulate and make sure people have faith in our. h. Money Supply graph: i. Increasing the Money Supply: If the Fed increases the money supply a temporary surplus will occur, causing the IR to fall. How does this affect AD? i. Money Supply, Interest Rate, Investment, AD ii. Graph:

4 iii. If the Fed DECREASES Money Supply: iv. Money Supply, Interest Rate, Investment, AD v. Graph: j. Fractional Reserve Banking: When banks hold only a small portion of deposits to cover potential withdrawals and then. If we all went to the bank at the same time what would happen? k. Bank Balance Sheets: i. Demand Deposits ii. Required Reserves iii. Excess Reserves iv. Balance Sheet Assets Liabilities v. It is balanced because the totals must. Graphing Monetary Policy A. If the Fed INCREASES money supply. IR, Investment, AD, GDP, PL S&D of Money Investment Demand AD/AS

5 B. If the Fed DECREASES money supply. IR, Investment, AD, GDP, PL S&D of Money Investment Demand AD/AS C. There are three shifters of Money Supply a. Reserve Requirement (AKA reserve ratio) i. Money Multiplier: 1/Reserve Ratio ii. Example: Interest Rate Review: iii. If there is a recession, what should the Fed do? iv. If there is inflation what should the Fed do? b. The Discount Rate: to increase the money supply, the Fed should the discount rate. To decrease the money supply, the Fed should the discount rate. c. Open Market Operations ( ) is when the Fed This is the most important and widely used monetary policy. To increase the Money Supply the Fed should government securities. To decrease the money supply, the Fed should government securities. d. Bonus: Federal Funds rate: The FFR is the. The Fed can t tell banks what IR to use, they decide on their own. They do set a and use to hit that target. Loanable Funds

6 A. Loanable Funds Market: Is a real interest rate of 50% good or bad? for borrowers, good for. The Loanable Funds market is the. This market should the effect on interest rates. Demand has an relationship between IR and Quantity of loans demanded. Supply has an relationship between IR and Quantity of loans demanded. This is NOT the same as the. B. Loanable Funds Graph C Loanable Funds Shift Demand Shifters Supply Shifters Fiscal Policy Consumption is the most important part of the economy. Consumers will spend a certain amount no matter what. This is called. This is usually to pay for necessities. Consumer spending is made up of autonomous spending and (Income after taxes) If incomes are less than autonomous spending then there is or negative savings. What happens if incomes fall and people stop buying things? Who steps in. The Government has two different tool boxes it can use. Fiscal Policy Monetary Policy

7 Contractionary Fiscal Policy Laws that reduce, decrease Close a Expansionary Fiscal Policy ( ) laws that reduce and increase. Expansionary Fiscal Policy Contractionary Fiscal Policy If Recession the G, AD, GDPr PL u% and π Or T, AD, GDPr PL u% and π If Inflation the G, AD, GDPr PL u% and π Or T, AD, GDPr PL u% and π Discretionary Fiscal Policy Automatic Fiscal Policy Weaknesses of Fiscal Policy: Crowding Out Effect: Explanation: Graph:

8 Phillips Curve The Phillips Curve shows the tradeoff between In general there is an inverse relationship between Short Run Phillips Curve What happens when AS falls causing stagflation? Short Run V. Long Run: In the Long Run there is no trade-off between inflation and unemployment LRPC = LRAS= AD/AS and the Phillips Curve Show what happens on both graphs given each scenario AD Increase

9 Recessionary Gap AND AD Falls Start at Full Employment. AS Falls Start at Recessionary Gap, AS goes up