24-1 GDPGDP == + Consumption by Households Investment by Businesses Government Purchases Expenditures By Foreigners Wages Rents Interest Profits Statistical Adjustments + Two Approaches to GDP

26-2 Unemployment Types of unemployment –Frictional (search and wait) –Structural (occupational and geographical) –Cyclical Full employment redefined –No cyclical unemployment Natural rate of unemployment Full employment rate

26-3 Inflation Rise in general level of prices Consumer price index (CPI) –Market basket –300 goods and services –Typical urban consumer –2 year updates CPI Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in = x 100

Rate of Inflation Rate of inflation This year index – last year index last year index 26-4

29-5 Changes in Equilibrium Real Domestic Output, GDP Price Level AD AS P1P1 P2P2 Q2Q2 Q1Q1 QfQf AD 1 Increase in Aggregate Demand Demand-Pull Inflation **increase in price level diminishes the multiplier effect Inflationary GDP gap

29-6 Changes in Equilibrium Real Domestic Output, GDP Price Level AD 1 AS P1P1 P2P2 Q1Q1 Q2Q2 QfQf AD 2 Decrease in Aggregate Demand Creates a Recession a c b **No change in price level protects full multiplier effect Negative GDP gap

29-7 Real Domestic Output, GDP Price Level AD AS 1 P1P1 P2P2 Q1Q1 QfQf Decrease in Aggregate Supply Cost-Push Inflation AS 2 a b Changes in Equilibrium

29-8 Real Domestic Output, GDP Price Level AD 1 AS 2 P1P1 P2P2 Q2Q2 Q1Q1 Increases in Aggregate Supply – Full-Employment With Price-Level Stability AS 1 b AD 2 c P3P3 Q3Q3 a Changes in Equilibrium

The Phillips Curve The graphical representation of the relationship between the rates of Unemployment and Inflation.

The Long-Run Phillips Curve Annual Rate of Inflation (Percent) Unemployment Rate (Percent) PC LR PC 3 PC 2 PC 1 a1a1 b1b1 a2a2 a3a3 b2b2 b3b3 c3c3 c2c At natural rate of unemployment

Taxes and Aggregate Supply Supply-side economics Tax incentives to work Tax incentives to save and invest The Laffer curve Tax Rate (Percent) Tax Revenue (Dollars) 100 m 0 n l m Laffer Curve Maximum Tax Revenue 35-11

The Monetary Multiplier Monetary multiplier = 1 required reserve ratio New Reserves $100 $20 Required Reserves $80 Excess Reserves $100 Initial Deposit $400 Bank System Lending Money Created Graphic Example = 1 R 32-12

Demand for Money Rate of interest, i percent Amount of money demanded (billions of dollars) Amount of money demanded (billions of dollars) Amount of money demanded and supplied (billions of dollars) = + (a) Transactions demand for money, D t (b) Asset demand for money, D a (c) Total demand for money, D m and supply DtDt DaDa DmDm SmSm

Loanable Funds

30-15 Expansionary Fiscal Policy Real Domestic Output, GDP Price Level AD 2 Recessions Decrease Aggregate Demand AD 1 $5 Billion Additional Spending Full $20 Billion Increase in Aggregate Demand AS $490$510 P1P1

30-16 Contractionary Fiscal Policy Real Domestic Output, GDP Price Level AD 3 Reduce Demand Pull Inflation AD 4 $3 Billion Initial Decrease In Spending Full $12 Billion Decrease in Aggregate Demand AS $510$522 P1P1

30-17 Crowding Out Real Interest Rate (Percent) Investment (Billions of Dollars) ID 1 ID 2 a bc Interest Rate Rise Will Decrease Investment a to b Crowding- Out Effect A Large Public Debt to Finance Public Investment Will Cause… If Public Spending Spurs More Private Investment Will Increase to ID 2

Self-Correction New classical view –Rational expectations theory –Monetarists Automatic correction will occur Speed of adjustment Unanticipated price-level changes Fully anticipated price-level changes 36-18

Q 0 Dollar Price of 1 Pound Quantity of Pounds P Flexible Exchange Rates The Market for Foreign Currency (Pounds) D1D1 S1S1 Dollar Depreciates (Pound Appreciates) Dollar Appreciates (Pound Depreciates) Exchange Rate: $2 = £1 $2 $3 $1 Q1Q