5A change in Demand versus a change in the Quantity Demanded √ Moves the curveIncomeFuture Expectations# of BuyersConsumer InformationTaste and PreferenceSubstitues and ComplementsChange in Quantity Demanded√ Moves Along the SAME curve• Caused only by Price change.
6Price Change P QD $5 4 3 2 1 10 20 35 55 80 P D o Q Price of Corn $5 QQuantity of Corn
7GRAPHING DEMAND Increase in Quantity Demanded P QD $5 4 3 2 1 10 20 35 Price of CornPIncreasein QuantityDemanded$54321CORNPQD$54321102035558030406080+IncreaseinDemandD’DoQQuantity of Corn
8A change in Supply versus a change in the Quantity Supplied √ Moves the curveCosts of ProductionFuture Expectations# of SellersTaxes and SubsidiesPrices of goods using same resourcesTime period of productionChange in Quantity Supplied√ Moves Along the SAME curve• Caused only by Price change.
9Price Change P QD $5 4 3 2 1 10 20 35 55 80 P S o Q Price of Corn $5 QQuantity of Corn
10GRAPHING SUPPLY Increase in Supply P QS $5 4 3 2 1 60 50 35 20 5 80 70 Price of CornPIncreaseinSupplyS’S$54321CORNPQS$543216050352058070604530Increasein QuantitySuppliedoQQuantity of Corn
11Verbal Clues Use a correctly labeled graph and show… Analyze the effect…Explain the mechanism…Identify the area of…Show the impact…Calculate (number and process)…Show price and output…Compare before and after…Two separate graphs correctly labeled graphSide-by-sideWhat is the relationship…
12Distinguish between: Price and price level AS and S AD and D ASlr ASsr oPL1ASsrASlrAD1QfPrice LevelReal domestic output
13GROSS DOMESTIC PRODUCT Defining…Market Value of the total goods and services produced within the boundaries of the US whether by Americans or foreigners in one year.
14+ + + + + + + G D = P = GROSS DOMESTIC PRODUCT Consumption Wages Expenditures ApproachIncome ApproachConsumptionby HouseholdsWages++RentsGDP+Investmentby Businesses=+=Interest+GovernmentPurchasesProfits++Expendituresby ForeignersStatisticalAdjustments
15NOMINAL GDP vs. REAL GDP Nominal GDP … reflects the current price level of goods and services and ignores the effect of inflation on the growth of GDP.… this measure is called Current Dollar GDP.Real GDP… measures the value of goods and services adjusted for change in the price level. It will reflect the real change in output.… This measure is called the Constant Dollar GDP.… indicates what the GDP would be if the purchasing power of the dollar has not changed from what it was in a base year. The government currently uses 2000 as its base year for Real GDP measurement.
16GDP Price Index x 100 = = Nominal GDP Real GDP Price Index in a givenyear=Price of market basketin specific yearPrice of same marketbasket in base yearx 100Real GDP=Nominal GDPPrice Index(in hundredths)
17Disposable Income = C + S By subtracting from Personal Income, the dollars lost to taxes, we have the Disposable Income. This is the “bottom” line of national income accounting.Disposable Income = C + S
18Unemployment Rate = Unemployed Labor Force Frictional – “temporary”, “transitional”, “short-term” (“between jobs” or “search” unemployment) (seasonal work)Structural – “technological” or “long term”. basic changes in the “structure” of the labor force which make certain “skills obsolete”.Cyclical – “economic downturns” in the business cycle.
19The Full employment rate of unemployment or the Natural Rate of Unemployment (NRU) is present when the economy is producing its potential output.The Natural Rate of Unemployment exists when the cyclical unemployment is zero.
20CPI = x 100 Inflation A rising of the general level of prices Price of the same marketbasket in 2000x 100CPIPrice of the market basket in the particular yearProducer Price Index (PPI) Prices at the wholesale or production level which are early indicators of inflation.
21Real and Nominal Income Nominal income … is the number of dollars earned as rent, wages, interest or profitReal income… measures the amount of goods and services nominal income can buy.√ If nominal income rises faster than price level, real income will rise.√ If the price level increases faster than nominal income, then real income will fall.√ Your real income falls only when nominal income fails to keep up with inflation.
22Qf is the amount of Real GDP at full employment. Long Run EquilibriumIn the extended AD-AS model, equilibrium occurs at the intersection of AD and the ASlr and the ASsr.Qf is the amount of Real GDP at full employment.oPL1ASsrASlrAD1QfPrice LevelReal domestic output
23DEMAND-PULL INFLATION But…PL rises even more to PL3! and Self-CorrectionShort Run—Increase in AD shows point bPrice LevelASlrAS2srASsrLong RunNominal Wages rise and AS2sr moves left. RGDP returns to previous level on AslrBut…PL rises even more to PL3!cPL3[7%]bPL2[5%]aPL1[2%]AD2AD1oQfY2Real domestic output
24with government action COST-PUSH INFLATIONwith government actionIf government stimulates AD to dotted line, an inflationary spiral will occur…PL3 at Qf. We have Full Employment but at a higher price level.Price LevelASlrAS2srASsrcPL3[5%]bPL2[3%]aPL1[2%]AD2AD1oY2QfReal domestic output
25with NO government action COST-PUSH INFLATIONwith NO government actionASlrAS2srIf government lets the recession take its course, nominal wages will fall in the long run and return to point a…PL1 at Qf.Price LevelASsrcPL3[5%]aPL1[2%]AD1oQfReal domestic output
26RecessionThis decline in the price level will eventually shift the AS1sr to AS2sr. Price level declines to PL3 at Qf . Shown at point c.ASlrAS1srPrice LevelAS2sraPL1[5%]PL2[3%]bPL3[2%]cAD1AD2oQfY2Real domestic output
28The Phillips Curve Summary The short run Phillips Curve is downward sloping.Aggregate Demand changes move along the same short run Phillips curve.Aggregate Supply changes create new short run Phillips curves.√ In the long run, there is not a stable relationship between unemployment and inflation.√ The long-run Phillips curve is the vertical line at the natural rate of unemployment.
29Expansionary Fiscal Policy Contractionary Fiscal Policy Goal: To Reduce Unemployment and Effects of Recession…√ Increase Government Spending√ Decrease Tax Rates…Or Combination of the TwoContractionary Fiscal PolicyGoal: To Reduce Demand—Pull Inflation…√ Decrease Government Spending√ Increase Tax Rates…Or Combination of the Two
30EXPANSIONARY FISCAL POLICY the multiplier at work...$20 billion decrease in tax rates; $15 billion in new consumption spendingAS$60 billionincrease inAggregateDemandPrice levelP2P1AD1AD2MPS = .25$490$550Real GDP (billions)
31CONTRACTIONARY FISCAL POLICY the multiplier at work...$20 billion increase in tax rates; $15 billion lost in consumption spendingAS$60 billiondecrease inAggregateDemandPrice levelP2P1AD3MPS = .25AD4$490$550Real GDP (billions)
32Quantity of Loanable Funds Crowding —Out EffectIncreased demand for loanable funds by government raises the interest rate.Si%Real Interest Rate, (percent)i%D2DLF0LF1Quantity of Loanable Funds
33+ + M3 M2 MI Large time deposits Money market accounts Savings depositsSmall time depositsM2+Checkable depositsTravelers checksCurrencyMI
34The Money MarketSupply of money is a vertical line since monetary authorities (FED) and financial institutions have provided the economy with a certain stock of money.i%$$ demandedDmi%1Sm
35√ The banking system creates a “multiplied” amount. √ One bank can loan only its excess reserves and is limited by those reserves in creating money.√ The banking system creates a “multiplied” amount.The Money MultiplierMoneyMultiplierRequired reserve ratio1=MaximumDemand-Depositcreation=ExcessreservesxMoneyMultiplierCurrency drain and no creditable customers will decrease the amount multiplied.
36EASY MONEY Goal: Cheap, available credit; increase the money supply MS i% In C AD PL RGDPEasy money is reinforced by the Net Export Effect
37Quantity of money demanded and supplied Easy Monetary Policy And Equilibrium GDPSm1Sm2Sm3InvestmentDemand10861086Real rate of interest, iDmQuantity of money demanded and suppliedAmount of investment, iASIf the Money SupplyIncreases to Stimulatethe Economy…Interest Rate DecreasesPL3Price levelInvestment IncreasesPL2AD & GDP Increaseswith slight inflationPL1AD3(I=$25)AD2(I=$20)Increasing money supplycontinues the growth –but, watch Price Level.AD1(I=$15)Real domestic output, GDP
38Tight Money Goal: Restrict credit; decrease the money supply MS i% In C AD PL RGDPTight money is reinforced by the Net Export Effect
39Quantity of money demanded and supplied Tight Monetary Policy And Equilibrium GDPSm3Sm2Sm1InvestmentDemand10861086Real rate of interest, iDmQuantity of money demanded and suppliedAmount of investment, iASIf the Money SupplyDecreases to “cool”the Economy…Interest Rate IncreasesPL1Price levelInvestment DecreasesPL2AD & GDP Decreaseswith lower PLPL3AD1(I=$25)AD2(I=$20)Decreasing money supplycontinues the “cooling” –as Price Level falls.AD3(I=$15)Real domestic output, GDP
40Nominal Rate =Real Interest rate + expected rate of inflationReal Interest Rate =Nominal rate—expected rate of inflation
42Money Market Graph—Nominal Interest Rate The supply of money is vertical no matter what the interest rate is on the vertical axis. The FED controls the supply of money.Smi%Q of $$ demandedDmThe demand for money is composed of the transaction demand and asset demand.i%eQe
43Loanable Funds Market—Real Interest Rate Demand is:• Business for investment• Consumer for spending• Government for Deficit spendingrSLFreDLFSupply is mostly from private savingsQeQ of LFChanges in the real interest rate caused by movements of demand (from borrowers) and supply (from savers).
44Classical View:√ AS is vertical and determines the output at Qf√ AD is stable and determines the price level as long as money supply is stable.√ If AD is unstable, prices and wages adjust.ASPrice LevelP1P2AD1AD2QfReal Domestic OutputA shift to AD2 shows that the price level declines.
45Keynesian View: AS √ AS is horizontal up to Qf then becomes vertical √ Product prices and wages are downward inflexible√ AS is horizontal up to Qf then becomesvertical√ If AD is unstable, changes in AD have no effect on PL but affect RGDP.ASPrice LevelReal Domestic OutputP1AD1AD2Q2QfMovement from AD1 to AD2 reduces the Real GDP but the PL remains constant.
46Self-Correction AS2 ASLR AS1 P3 P2 P1 AD2 AD1 Q1 NEW CLASSICAL VIEW OF SELF-CORRECTIONSelf-CorrectionAD increases moves economy from a to b.Price level rises (P2) and then self-correction to c by shifting left to AS2 as Nominal Wages rise.AS2ASLRAS1Price LevelP3cP2bP1aAD2AD1Q1Real Domestic Output
47Deficits, Surpluses and Debt A budget deficit is the amount by which the government expenditure exceeds the government revenue in a particular year.A budget surplus is the amount by which the government revenue exceeds the government expenditure in a particular year.The National or Public Debt is the accumulated deficits and surpluses of the government over time.
48√ Comparative Advantage …is the ability to produce an item at a lower opportunity cost. Resources are scarce, so that one can only produce more of one product by taking the resources away from another. It means that total world output will be greatest when each good is produced by the nation which has the lowest domestic opportunity cost.√ As a result of trade, countries that trade products based on their own specialization will have more of BOTH products (produced and traded for).√ Terms of Trade…the exchange ratio between goods traded. This ratio explains how the gains from international specialization and trade are divided among the trading nations; it depends on the world supply and demand for the two products.
49The intersection will be the exchange rate. Flexible exchange ratesS$ Price ofForeign CurrencyThe intersection will be the exchange rate.$fcDQfcQuantity of Foreign Currency
50A nation’s Balance of Payments records all the transactions that take place between its residents and the residents of a foreign nation.Current AccountMdse. TradeServices TradeNet Investment IncomeNet TransfersCapital AccountReal InvestmentFinancial InvestmentsOfficial Reserves Account+ to balance a deficit—to balance a surplus=
51Determinants of exchange rates: Changes in tastesChanges in relative incomesChanges in relative pricesChanges in relative interest ratesSpeculation in currencies