1. Massive Macro Cram Kit!

2. Topics and percentages
8-12% Basic Economic Concepts
12-16% Measurement of Economic Performance
10-15% National Income and Price Determination
15-20% Financial Sector
20-30% Inflation, Unemployment, and Stabilization Policies
5-10% Economic Growth and Productivity
10-15% Open Economy: International Trade and Finance

3. 8-12% Basic Economic Concepts
A. Scarcity, choice, and opportunity costs
B. Production possibilities curve
C. Comparative advantage, absolute advantage,
specialization, and exchange
D. Demand, supply, and market equilibrium
E. Macroeconomic issues: business cycle, unemployment,
inflation, growth

4. Production Possibilities
Assumptions:
Full Employment
Fixed Resources and Technology
Movements
Along curve shows opportunity cost
Outward shift illustrates economic growth
Inward shift indicates destruction of resources
Producing Capital Goods will lead to greater economic growth than producing consumer goods. (Butter will lead to more growth than guns)

5. Production Possibilities Graph
Capital Goods
Points A,B,C, are efficient pts.
Point D is underutilization
Point E is economic growth A E
May Lead to most
Future growth
May Lead to most
Future economic growth B D C
F.E.
F.E.1
Consumer Goods

6. Supply and Demand Factors
Demand Changes when:
Income changes
Related Products, complements and substitutes, (price or quality change)
Expectations (future price change)
Consumers (more or less added)
Tastes, Fads, Preferences change

7. Demand Increase: As Demand Increases, Price and Quantity Increase as well.

8. Demand Decrease: As Demand Decreases, Price and Quantity decrease as well

9. Supply Factors Supply Changes When:
Input prices change (resources and wages)
Government (tariffs, quotas, and subsidies)
Number of sellers change
Expectations (about price and product profitability change)
Disasters (weather, strikes, etc..)

10. Supply Increase: As Supply Increases, Quantity Increases, but Price Falls.D1
Quantity Q1 Q2

11. Supply Decrease: As Supply Decreases, Quantity Decreases, but Price Increases.

12. Comparative Advantage
A nation should specialize in producing goods in which it has a comparative advantage: ability to produce the good at a lower opportunity cost.
Example:
Cheese Wine
Spain: 2 pounds 2 Cases
France 2 pounds 6 Cases
Spain should produce cheese (1C = 1W)
France should produce wine (1W = 1/3C) :

13. Currency Terms
Appreciation: Currency is increasing in demand (stronger dollar)
U.S. Currency will appreciate when more foreigners: travel to the U.S., buy more U.S. goods or services, or buy the U.S. dollar to invest in bonds

14. Currency Terms
Depreciation: Currency is decreasing in demand (weaker dollar) Being SUPPLIED in exchange for other currency.
U.S. Currency will depreciate when fewer foreigners: travel to the U.S., buy fewer U.S. goods or services, or sell the U.S. dollar to invest in their own bonds

15. Business Cycles
The increases and decreases in Real GDP consisting of four phases:
Peak: highest point of Real GDP
Recession: Real GDP declining for 6 months
Trough: lowest point of Real GDP
Recovery: Real GDP increasing (trough to peak)

16. Business Cycle
Full Employment
Peak -- Greatest spending and lowest unemployment. Inflation becomes a problem.
Contraction/Recession -- Reduction of spending levels and increasing unemployment. Some cyclical unemployment begins.
Trough -- Least spending and highest unemployment
Expansion -- Spending increases and unemployment decreases
We want to avoid extreme inflation and extreme unemployment. We want stability!

17. The two big problems…
The two big problems that plague the economy are:
INFLATION
UNEMPLOYMENT
People generally prefer steady, stable growth to large “ups” and “downs.” Therefore, government policies, both fiscal and monetary (see later sections), are aimed at flattening the business cycle.
The government wants not only to stimulate the economy when it’s slow, but also to slow it down when it’s growing too quickly.

18. 12-16% Measurement of Economic Performance
A. National income accounts
1. Circular flow
2. Gross domestic product
3. Components of gross domestic product
4. Real versus nominal gross domestic product
B. Inflation measurement and adjustment
1. Price indices
2. Nominal and real values
3. Costs of inflation
C. Unemployment
1. Definition and measurement
2. Types of unemployment
3. Natural rate of unemployment

19. Circular Flow of Economic Activity
Households supply resources (land, labor, capital, entrepreneurial ability) to the resource market. Households demand goods and services from businesses.
Businesses demand household resources and supply goods and services to the product (factor) market.

21. Gross Domestic Product
GDP (Gross Domestic Product): The total dollar (market) value of all final goods and services produced in a given year. Expenditure Formula:
Consumption (C) +
Business Investment (I) +
Government Spending (G) +
Net Exports (Xn)

22. GDP: What Counts: Goods Produced but not Sold (I)
Goods produced by a foreign country (Japan) in the U.S. (Honda, Toyota)
Government spending on the military
Increase in business inventories

23. GDP: What DOES NOT count:
Intermediate Goods (Tires sold by Firestone to Ford)
Used Goods
Non-Market Activities (Illegal, Underground)
Transfer Payments (Social Security)
Stock Transactions

24. Shortcomings of GDP: Leading to GDP being understated.
Nonmarket activities: (services of homemakers) does not count.
Leisure: Does not include the value of leisure.
Does not include improvements in product quality.
Underground economy

25. GDP: Overstated Includes damage to the environment
Includes more spending on healthcare-Americans being unhealthy.
Includes money spent to fight crime-more police officers, more jails, etc…

26. Real GDP Real GDP= Nominal GDP adjusted for inflation. Calculation:
Price Index in Hundredths( deflator)
Example:
U.S Real GDP= $12,4558 (billions)
(based on 2000)
$ Trillion

27. Real GDP Per Capita
Most commonly used to compare and measure each country’s standard of living and overall economic growth.
Real GDP/Nation’s Population

28. Inflation Rise in the general level of prices
Reduces the purchasing power of money
Measured with the Consumer Price Index (CPI)
Reports the price of a market basket , more than 300 goods that are typically purchased by an urban household

29. Calculating Inflation
CPI in Recent Year – CPI in Past Year
Divided by CPI in Past Year
(Number then Multiplied by 100)
Example: CPI = 179.9
2001 CPI = 177.1
Rate of Inflation: = 1.58%
177.1

30. Types of Inflation
Demand Pull Inflation: ‘too much money chasing too few goods.”
AD Curve will shift to the right, resulting in a higher Price Level and greater Output (until reaching Y*
Cost-Push Inflation: Major cause is a supply shock-OPEC cutting back on oil production
AS Curve will shift to the left resulting in a higher Price Level and a decrease in Real GDP.

31. Real and Nominal Terms Real Income = Nominal Income
Price Index (Hundredths)
Real Interest Rate = Nominal Interest Rate – Inflation Rate
Nominal Interest Rate = Real Interest Rate Inflation Premium
(anticipated inflation)

32. Inflation: Winners & Losers
Debtors who borrow money that will be repaid with “cheap” dollars.
Those who have anticipated inflation
Losers:
Savers (especially savings accounts)
Creditors (Banks will be repaid with those “cheap” dollars
Fixed-Income Recipients (retirees receiving the same monthly pension)

33. Unemployment Calculation: Number of Unemployed Labor Force
(Multiplied by 100 to put as a %)
The Labor Force is the total of employed and unemployed workers.
U.S. unemployment should be about 5%

34. Employed You are considered to be employed if:
You work for 1 hour as a paid employee (so part-time workers count)
You are temporarily absent from work (illness, strike, vacation)
You work 15 hours or more as an unpaid worker (family farms are common)

35. Unemployed
Must be looking for work (at least 1 attempt in the past 4 weeks)
Are reporting to a job within 30 days
Are temporarily laid off from their job

36. Not In Labor Force A person who is not looking for work:
Full-time students
Stay at home parents
Discouraged workers: those who have given up hope of finding a job.
Retirees

37. Unemployment
100% of the people will never be employed, so the government considers 4-6% unemployment to be “full employment.”
Types of Unemployment
Frictional - temporary and unavoidable
Structural - results from changes in technology or a business restructure (ex. Merger)
Seasonal- occurs when industries slow or shut down for a season
Cyclical - results from a decline in the business cycle.
We can never be at Full Employment if there is any percentage cyclically unemployed.

38. 10-15% National Income and Price Determination
A. Aggregate demand
1. Determinants of aggregate demand
2. Multiplier and crowding-out effects
B. Aggregate supply
1. Short-run and long-run analyses
2. Sticky versus flexible wages and prices
3. Determinants of aggregate supply
C. Macroeconomic equilibrium
1. Real output and price level
2. Short and long run
3. Actual versus full-employment output
4. Economic fluctuations

39. Consumption and Saving
As income increases, both consumption and savings will increase.
The determinants of overall consumption and savings are: (More money or a positive outlook will increase consumption and reduce savings. Less money or a negative outlook will increase savings and reduce consumption.
Wealth (financial assets)
Expectations about future prices and income
Real Interest Rates
Household Debt
Taxes

40. Marginal Propensities
Marginal Propensity to Consume (MPC) and the Marginal Propensity to save (MPS) must equal 1.
The MPS is used to derive the spending multiplier, which equals: _
MPS
If the MPS is .2, the spending multiplier is 5.
Any increase in spending must be multiplied by 5 to determine the overall increase in Real GDP.

41. Aggregate Demand Downward sloping: Real-Balances Effect: change
in purchasing power
2. Interest-Rate Effect: Higher
interest rates curtail spending
Foreign Purchase Effect:
Substitute foreign products for
U.S. products
Price
Level
AD (C + I + G + X)
Real GDP

42. Aggregate Demand Determinants of AD: C + I + G + Xn (Yes, its GDP)
An increase in any of these, due to lower interest rates or optimism will increase AD and shift the curve to the right.
A decrease in any of these: more debt, less spending, tax increase, will cause a decrease in AD and shift the curve to the left

43. Aggregate Demand Determinants
Consumption
Wealth
Expectations
Debt
Taxes
Investment
Interest Rates
Expected Returns
Technology
Inventories
Government
Change in Gov. spending
Net Exports
National Income Abroad
Exchange Rates

44. Aggregate Supply Factors:
R: resource prices (The CELL/ wages and materials, as well as OIL)
E: environment [legal-institutional] (Taxes, Subsidies, more regulation)
P: productivity (better technology)

45. Aggregate Supply Short Run: Long Run:
Assumes that nominal wages are “sticky” and do not respond to price level changes.
Is Upward sloping as businesses will increase output to maximize profits
Generally considered to be a year or less.
Long Run:
Curve is vertical because the economy is at its full-employment output.
As prices go up, wages have adjusted so there is no incentive to increase production.
Generally considered to be longer than a year.

46. Aggregate Supply Graph
Price Level AS
Inflation
Short Run
Long Run
Recession
Growth
Extended vertical line
Illustrates the LRAS and
Y* (Full-Employment) Y*
Real GDP

47. Another look as AS LRAS SRAS PL
Changes that lead to a new equilibrium on the left of LRAS = Recession
Changes that lead to a new equilibrium on the right of LRAS = Inflation (AKA “an overheated economy”) PL AD Y*
RGDP

48. NOTE!!
For the AP exam, assume that there are only two determinants that simultaneously affect BOTH short term aggregate supply and aggregate demand
business tax changes and
foreign currency changes.
A change in business taxes shifts AD and AS in the same direction
A change in FX sends both curves in the opposite directions.

49. Demand-Pull InflationAS
Price Level P2 P1
AD2
AD1 (C + I + G + X) Y*
Real GDP

50. Cost-Push Inflation AS2 Price Level AS1 P2 P1 AD1 ( C + I + G + X) Y
Real GDP

51. Demand-Pull Inflation vs. Cost-Push Inflation

52. DEMAND-PULL INFLATION
ASLR
AS2
AS1 c P3
Price Level P2 b P1 a
AD2
AD1 o Q1
Real domestic output

53. COST-PUSH INFLATION Occurs when short-run AS shifts left Price Level o
ASLR
AS2
AS1
Price Level P2 b P1 a
AD1 o Q2 Q1
Real domestic output

54. COST-PUSH INFLATION Even higher price levels
Government response with increased AD
ASLR
AS2
AS1
Even
higher
price
levels c P3
Price Level P2 b P1 a
AD2
AD1 o Q2 Q1
Real domestic output

55. COST-PUSH INFLATION Price Level o Real domestic output
If government allows a recession to occur
ASLR
AS2
AS1
Price Level P2 b P1 a
AD1 o Q2 Q1
Real domestic output

56. COST-PUSH INFLATION Nominal wages fall & Price Level AS returns
If government allows a recession to occur
ASLR
AS2
AS1
Nominal
wages fall &
AS returns
to its original
location
Price Level P2 b P1 a
AD1 o Q2 Q1
Real domestic output

57. 15-20% Financial Sector (Money and Banking)
A. Money, banking, and financial markets
1. Definition of financial assets: money, stocks, bonds
2. Time value of money (present and future value)
3. Measures of money supply
4. Banks and creation of money
5. Money demand
6. Money market
7. Loanable funds market
B. Central bank and control of the money supply
1. Tools of central bank policy
2. Quantity theory of money
3. Real versus nominal interest rates

58. Money Supply Terms M1= Checkable Deposits and Currency
M2= M1 + Savings deposits, money market accounts, small time deposits (less than $100,000)
Velocity of Money Equation:
MV = PQ ( GDP) (M= Money Supply and V = Velocity (number of times per year the average dollar is spent on goods and services.

59. Banks and Balance Sheets
Assets Liabilities
Reserves $15,000 Checkable Deposits $100,000
Securities $15,000
Loans $70,000
If the current reserve requirement is 10%:
1. What is the amount of new loans this bank can generate?
Answer: $100,000 Checkable deposits X a 10% reserve requirement = $10,000 required reserves. If the bank has $15,000 in reserves, $5,000 of those are excess reserves and can be loaned out .
2. How much in new loans can be generated by the entire banking
system?
Answer: Money Multiplier = 1/Required Reserve Ratio=1/.10
10 X $5,000 = $50,000

60. FED and the Money Market
Nominal Interest
Rate
MS1
MS2
Vertical curve-Supply controlled
By the FED. An increase in MS
leads to a rightward shift and
lower nominal interest rates.
nir1
nir2 MD Q1 Q2
Quantity of Money

61. Interest Rate-Investment
Expected Rate of Return: Amount of Profit (expressed as a percentage) a business expects to gain on a project/investment.
This rate must be greater than the interest in order to be profitable.
The Real Rate of Return is most important. An expected profit of 10%, that costs 5% in interest = The real rate of return: 5%.

62. Investment Demand Curve:
Real Rate of
Return
At lower real interest rates businesses will
Increase investment , leading to an increase
In AD (aggregate demand). At higher rates of
Interest, less money will be invested r1 r2 ID Q1 Q2
Quantity of Investment

63. Shifts of the Investment Demand Curve
Expected Rate of Return
( Real Interest Rate.)
A shift from ID1 to ID2
Represents an increase in
Investment demand. A shift
From ID1 to ID3 represents a
decrease in investment
Demand.
ID2
ID1
ID3
Quantity of Investment

64. Loanable Funds Market and Expansionary Fiscal Policy
Used for FISCAL POLICY (Government spending-Deficit Spending)
An increase in Gov. spending increases the demand for loanable funds and raises real interest rates
Real Interest Rate
SLF R2 R1
DLF2
DLF1 Q1 Q2
Quantity of Funds

65. Loanable Funds Market and Contractionary Fiscal Policy
Used for FISCAL POLICY (Government spending-Deficit Spending)
A decrease in Gov. spending decreases the demand for loanable funds and lowers real interest rates
SLF
Real Interest Rate R1 R2
DLF1
DLF2 Q2 Q1
Quantity of Funds

66. Nominal: with Inflation Real: without Inflation

67. GDP
Nominal GDP: GDP measured in terms of current Price Level at the time of measurement. (Unadjusted for inflation)
Real GDP: GDP adjusted for inflation; GDP in a year divided by a GDP deflator (Price Index) for that year

68. INCOME
NOMINAL INCOME: number of dollars received by an individual or group for its resources during some period of time
REAL INCOME: amount of goods and services which can be purchased with nominal income during some period of time; nominal income adjusted for inflation

69. INTEREST RATE (I%)
NOMINAL I%: interest rate expressed in terms of annual amounts currently charged for interest; not adjusted for inflation
REAL I%: interest rate expressed in dollars of constant value (adjusted for Inflation) and equal to the NOMINAL I% minus the EXPECTED RATE OF INFLATION

70. ANTICIPATED INFLATION
11% 6% = + 5%
Inflation
Premium
Nominal
Interest
Rate
Real
Interest
Rate

71. WAGES
NOMINAL WAGES: amount of money received by a worker per unit of time (hour, day, etc.);
Money Wage
REAL WAGES: amount of goods and sevices a worker can purchase with their NOMINAL WAGE; purchasing power of the nominal wage.
(Real = Nominal – Inflation rate)

72. NOMINAL/REAL TIPs
If nominal rates INCREASE and Price Level INCREASE, the CHANGE in Real is “indeterminable.”
If nominal Wage rates do NOT change and Price Level fall. REAL WAGES increase.
NOMINAL RATES “PIGGY-BACK” REAL RATES & NOT VICE VERSA.

73. 20-30% Inflation, Unemployment, and Stabilization Policies
A. Fiscal and monetary policies
1. Demand-side effects
2. Supply-side effects
3. Policy mix
4. Government deficits and debt
B. Inflation and unemployment
1. Types of inflation
a. Demand-pull inflation
b. Cost-push inflation
2. The Phillips curve: short run versus long run
3. Role of expectations

74. FISCAL POLICY CHANGES AD ….
Using Taxes and Government spending to stabilize the economy.
Controlled by the President and Congress
Discretionary Fiscal Policy: Congress must take action (change the tax rates) in order for the action to be implemented.
Automatic Stabilizers: Unemployment benefits, Progressive Tax System, these changes are implemented automatically to help the economy.
FISCAL POLICY CHANGES AD ….
EXCEPT when the question specifically states there is a change in business taxes.

75. Types of Fiscal Policy Expansionary Contractionary
Used to Fight a Recession
LOWER TAXES
INCREASE GOVERNMENT SPENDING
Contractionary
Used to fight Inflation
RAISE TAXES
DECREASE GOVERNMENT SPENDING

76. Expansionary Fiscal Policy
AS1
Price Level P2 P1
AD2
AD1 ( C + I + G + X )
Real GDP Y1 Y*

77. Contractionary Fiscal Policy
Raising taxes or reducing government spending to fight inflation and stabilize the economy.
Price Level AS P1 P2
AD1
AD2 Y*
Real GDP

78. Tax Multiplier [-MPC/MPS]
Remember, if the government decreases taxes, the result is not as great as a spending increase, since households will save a portion (MPS) of the tax cut.
The Tax Multiplier = -MPC /MPS
Example: If the MPC is .8 and the MPS is .2
Spending Multiplier = 1/.2 or 5
Tax Multiplier = -.8 /.2 or -4

79. Crowding-Out Effect
An Expansionary Fiscal Policy as previously diagrammed will lead to higher interest rates.
At higher interest rates, businesses will take out fewer loans and there will be a decrease in INVESTMENT (I)
At the same time there will be a decrease in CONSUMER SPENDING (C) as they will take out fewer loans as well.
This CROWDING OUT EFFECT will reduce the gain made by the expansionary fiscal policy.

80. Net Export Effect & Expansionary Fiscal Policy
Government spending has led to an increase in interest rates.
At higher interest rates, foreigners demand more U.S. dollars to invest in bonds.
This leads to an appreciation of the U.S. dollar.
This leads to a decrease in Net Exports, as foreigners now have to exchange more of their currency for the U.S. dollar to buy exports.
This decrease in Net Exports will reduce AD and counter to some extent the expansionary fiscal policy.

81. Net Export Effect & Contractionary Fiscal Policy
A decrease in government spending has led to a decrease in real interest rates.
At lower interest rates, foreigners demand less U.S. dollars to invest in bonds.
This leads to a depreciation of the U.S. dollar.
This leads to an increase in Net Exports, as foreigners now have to exchange less of their currency for the U.S. dollar to buy exports.
This increase in Net Exports will increase AD and further strengthen the contractionary fiscal policy.

82. Criticisms of Fiscal Policy
Timing Problems
Recognition Lag: identifying recession or inflation
Administrative Lag: getting Congress/President to agree to take action
Operational Lag: Time needed to see the results of the fiscal policy
Political Business Cycles: Politicians may take inappropriate action to get reelected (lower taxes during an inflationary period). Plus it is difficult to raise taxes

83. The Federal Reserve System (FED)
Control Monetary Policy
Headquartered in Washington D.C.
12 Federal Reserve Districts
Board of Governors (7 members) is the central authority
Members are appointed by the President and confirmed by the Senate

84. Federal Open Market Committee (FOMC)
Made up of 12 people: Board of Governors + New York FED President + 4 other regional presidents (who rotate)
Meets regularly to direct OPEN MARKET OPERATIONS (buying or selling of bonds) to maintain or change interest rates

85. FED and the Money Market
Nominal Interest
Rate
MS1
MS2
Vertical curve-Supply controlled
By the FED. An increase in MS
leads to a rightward shift and
lower interest rates.
nir1
nir2 MD Q1 Q2
Quantity of Money

86. Easy Money Policy on AD/AS
Buying Government Bonds, lowering the discount rate, or lowering reserve requirements, to fight a recession, by decreasing interest rates, increasing investment spending and/or consumption and increasing AD. AS
Price Level P2
AD2 P1
AD1 (C + I + G + X) Q1 QF
Real GDP

87. Effects of an Easy Money Policy
LOWER INTEREST rates which will lead to an INCREASE in INVESTMENT and CONSUMPTION.
The U.S. dollar will DEPRECIATE, leading to an increase in NET EXPORTS as well.
These effects STRENGTHEN the overall monetary policy (opposite of fiscal policy’s crowding-out and net export effect

88. FED and a TIGHT Money Policy
Nominal Interest
Rate
MS2
MS1
Vertical curve-Supply controlled
By the FED. A decrease in the
Money supply, shifts the MS
curve to the left and raises
interest rates.
nir2
nir1 MD Q2 12
Quantity of Money

89. Tight Money Policy and AD/AS
Selling bonds, raising the discount rate, or raising reserve requirements to fight inflation which will raise interest rates, decrease investment and/or consumption and decrease Aggregate Demand (AD).
Price Level AS P1 P2
AD1
AD2 QF
Real GDP

90. Effects of a Tight Money Policy
At the higher interest rates, INVESTMENT SPENDING, and CONSUMPTION will decrease.
At higher interest rates, the U.S. dollar will APPRECIATE (foreigners demand more U.S. securities). This will lead to a DECREASE in NET EXPORTS.
Again, the Monetary Policy is STRENGTHENED as a result, unlike the effects of a contractionary fiscal policy.

91. Extended AD-AS Model This is the other way to graph the AD-AS Model
Price Level
LRAS
SRAS P1 AD Y*
Real GDP
The intersection of the 3 curves
Is the Full-Employment Equilibrium

92. Extended AD-AS Model and Demand-Pull Inflation
In Demand-Pull Inflation, the AD curve has shifted to the right of the LRAS and SRAS intersection.
LRAS
Price Level
SRAS P2 PF
AD2
AD1 Y* Y2
Real GDP
The Price Level and Real GDP has increased.

93. Extended AD-AS and Demand-Pull Inflation
Mainstream economists will fight inflation as previously discussed: with either a tight monetary policy or a contractionary fiscal policy. The goal would be to move the aggregate demand curve to the left.
Classical economists would argue to DO NOTHING. As nominal wages rise, the SHORT-RUN AS curve will shift to the left (resources and wages are becoming more expensive), restoring the economy to its full-employment output level, but with a higher Price Level.

94. Extended AD-AS Model and Cost-Push Inflation
Cost-Push inflation occurs when the SRAS has shifted to the left
Of the LRAS and AD intersection.
SRAS2
LRAS
Price Level
SRAS1
Here the Price level has
Increased and REAL GDP
has decreased. P1 PF
AD1 Y1 Y*
Real GDP

95. Extended AD-AS and Cost-Push Inflation
Mainstream economists must decide whether to target the Price Level or Unemployment, before taking any action.
Classical economists would argue to DO NOTHING. Eventually, wages and resource prices must decrease and when they do the SRAS curve will shift back to the right, restoring the economy to its full-employment output level and the original Price Level.

96. Extended AD-AS Model and Recession
In a recession due to a decrease in AD, the AD curve is to the left of the LRAS and SRAS intersection; showing a decrease in both
the Price Level and Real GDP.
LRAS
Price Level
SRAS PF P1 AD Y1 Y*
Real GDP

97. Extended AD-AS and Recession
Mainstream economists will fight a recession as previously discussed: with either an easy money policy or an expansionary fiscal policy. The goal would be to move the aggregate demand curve to the right.
Classical economists would argue to DO NOTHING. The decrease in wages and resource prices will shift the SRAS curve to the right, restoring the economy to its full-employment output level, but with a LOWER price. (SELF-CORRECTION)

98. Short-Run Phillips Curve
Suggests an inverse relationship between the inflation rate and the unemployment rate.
Inflation
Rate
(percent)
When the unemployment rate is
Low (2%), the inflation rate will
Most likely be high (8%). 8
When the
Unemployment rate
Is high, inflation will
likely be low. 2
SRPC1 2 8
Unemployment Rate (percent)

99. Short-Run Phillips Curve
When the Government fights unemployment, typically higher inflation will result. When the Government fights inflation, typically, more unemployment will result. Thereby, we move along the Short-Run Phillips Curve. (Changes in AD = movements on the SRPC.
Inflation
Rate
(percent) B 7 2 A
SRPC1 3 6
Unemployment Rate (percent)

100. Shifting the Short-Run Phillips Curve
The Short-Run Phillips curve can also shift, this would mean that both the unemployment rate and inflation rate are changing at the same time. (A change in AS)
Inflation Rate %
Stagflation, unemployment and
Inflation occurring together
(OPEC decreasing Oil supply,
causes this type of shift) 5 4
SRPC2
SRPC1 6 7
Unemployment Rate %

101. Shifting the Short-Run Phillips Curve
The Short-Run Phillips curve can also shift, this would mean that both the unemployment rate and inflation rate are changing at the same time.
When Supply increases
(productivity surge in 90s)
more than demand, prices will fall, while GDP and employment
Increase; shifting the curve to the left.
Inflation Rate % 5 3
SRPC1
The SRPC is a mirror image of AS – If AS moves right, SRPC moves left.
SRP2 5 7
Unemployment Rate %

102. Long-Run Phillips Curve
The Long-Run Phillips Curve is vertical, like the Long Run Aggregate Supply Curve. So, in the long run there is no tradeoff between inflation and unemployment. Only the Price Level will change.
LRPC
Inflation Rate% 3
SRPC 5
Unemployment Rate %

103. Laffer Curve
What is the optimal tax rate? A tax of 0% will provide no tax revenue. A tax rate of 100% will also lead to no tax revenue (no incentive to work). Answer must be somewhere in between.
Tax Rate
100
Tax Revenue

104. Economic Philosophies
Classical: Believes that the government SHOULD NOT interfere in the economy. And believes in self-correction of economic problems.
Keynesian: Believes that GOVERNMENT SHOULD interfere in the economy (taxes, government spending). Most “mainstream” economists are Keynesians
Rational Expectations: Believes that monetary and fiscal policy have certain effects on the economy and take action to make these policies ineffective.

105. 5-10% Economic Growth and Productivity
A. Investment in Human Capital
B. Investment in Physical Capital
C. Research and development, and technological progress
D. Growth Policy

106. Economic Growth Five Factors connected to long run economic growth.
Supply Factors:
Increase in natural resources (quantity and quality)
Increase in human resources (quantity and quality)
Increase in capital goods
Improvements in technology
Demand Factors:
Increase in consumption by households, businesses, and government

107. Illustrating Economic Growth
Production Possibilities Curve
Capital Goods B A
PPC2
PPC1
Consumer Goods

108. Illustrating Long Run Growth
Can also be illustrated with the extended AD-AS Model.
LRAS2
LRAS1
SRAS2
SRAS1
Price Level P2 P1
AD2
AD1 Y1 Y2
Real GDP

109. 10-15% Open Economy: International Trade and Finance
A. Balance of payments accounts
1. Balance of trade
2. Current account
3. Capital account
B. Foreign exchange market
1. Demand for and supply of foreign exchange
2. Exchange rate determination
3. Currency appreciation and depreciation
C. Net exports and capital flows
D. Links to financial and goods markets

110. International Trade
Comparative Advantage and Specialization allows for economic growth and efficiency. (More of each good can be obtained by trading-Trading line illustrates this)
Trade barriers create more economic loss than benefits.
Today there is a trend towards free trade and a reduction in trade barriers.
Strongest arguments for protection are the infant industry and military self-sufficiency arguments.
WTO oversees trade agreements and disputes, but has become a target of protesters lately.

111. Exchange Rates and International Markets
The value of a foreign nation’s currency in relation to your own currency is called the exchange rate.
An increase in the value of a currency is called appreciation.
A decrease in the value of a currency is called depreciation.
Multinational firms convert currencies on the foreign exchange market, a network of about 2,000 banks and other financial institutions.

112. Types of Exchange Rate Systems
Fixed Exchange-Rate Systems
A currency system in which governments try to keep the values of their currencies constant against one another is called a fixed exchange-rate system.
Flexible Exchange-Rate Systems
Flexible exchange-rate systems allow the exchange rate to be determined by supply and demand.

113. Foreign Exchange Market
Let’s say a U.S. citizen travels to Japan. This transaction will provide a supply of the U.S. dollar and result in a demand for yen. It will become cheaper for the Japanese to buy the dollar and more expensive for Americans to buy the Yen. The Yen is Appreciating and the dollar is Depreciating.
Yen Price of
dollar
(Y/$)
Dollar Price
of Yen
($/Y)
SY1
S$1 P2
S$2 P1 P1
DY2 P2
DY1
D$1 Q1 Q2 Q1 Q2
Quantity of Yen
Quantity of U.S. Dollars

114. Balance of Payments: The sum of all transactions between U. S
Balance of Payments: The sum of all transactions between U.S. residents and residents of all foreign nations
Current Account: Shows U.S. exports and U.S. imports of goods and services.
Capital Account: Shows the U.S. investment (financial as well as capital-plants and factories) abroad and Foreign investment in the U.S.
Credits: A credit are those transactions for which the U.S. receives income (exports, foreign purchase of assets)
Debits: Those transactions that the U.S. must pay for: imports and purchasing of assets abroad.

115. Balance of Payments [continued]
The Current Account and Capital Account must be equal.
Official Reserves Account: The Central Banks of all nations hold foreign currency to make up any deficit in the combined capital and current accounts.
If the U.S. has more credits than debits it finances this difference by dipping into its reserve account.

116. So,………… That’s it!
Easy, huh?