2. M E = 1/MPS M T=MPC/MPS

4. Formulas Formulas $6,737[1994]/126.1[1987($4,540)]x100 = $5,343 [+$803.] “Real GDP deflates nominal GDP to actual value ”[ takes the air out of the nominal balloon] Base year[$50/$50=1x100=100] $46/$50x100=92[deflation of 8%] Price of Market Basket(2001 [nominal GDP] $64 Price of Market Basket(2001) [nominal GDP] $64 GDP Price Index = Price of same Market Basket(1998)x100 ;[R eal GDP] $50x100=128 GDP Price Index = Price of same Market Basket(1998)x100 ; [R eal GDP] $50x100=128 [GDP Deflator] in the base year (1998)[$64/128 x 100 = $50] [GDP Deflator] in the base year (1998) [$64/128 x 100 = $50] Unemployment 5,655,000 Labor Force x 100 = unemployment rate; 140,863,000 x 100 = 4% [Employed + unemployed] [135,208,000+5,655,000] [2000] Okun’sLaw or GDP gap3 % Okun’s Law or GDP gap)=U nemployment R ate over 6% x 2%; 7.5%, so 1.5x2% = 3 %. Or, $3 billion GDP Gap[$100 billion nominal GDP x.03% = $3 billion]. (2000-later year) (1999-earlier year) [*Change/original x 100] (2000-later year) (1999-earlier year) [*Change/original x 100] Current year’s index – last year’s index 172.2-166.6(5.6) Current year’s index – last year’s index 172.2-166.6(5.6) C.P.I. = Last year’s index(1999-earlier year) x 100; 166.6 x100 = 3.4% _________________________ “Rule of 70” “Rule of 70” = % annual rate of increase (3%) = 23 years “Real Income” “Real Income” measures the amount of goods/services nominal income will buy. %change in real income% change in nominal income% change in PL [% change in real income = % change in nominal income - % change in PL.] 5%10%5% 5% 10% 5% 70

5. Real GDP = Nominal GDP/Index X 100 Real GDP = Nominal GDP/Index X 100 $9,299.2[1999]/104.77[1996] x 100 = $8,875.8 [So, +$1,062.6] “Real GDP deflates nominal GDP to actual value” [takes the air out of the nominal balloon] $5,250.8 $3,774.7 $5,671.8 108.5 x 100=$_____ 108.1 x 100=$_____ 117.0 x100=$_____ 4,839 3,492 4,848 1. real GDP 1. Using the above formula, what is the real GDP for 1994 if nominal GDP was $6,947 trillion and the GDP deflator was 126.1? ($6,611/$5,610/$5,509) trillion. 2.real GDP 2. For 1996, what would real GDP be if nominal GDP were $7,636 trillion and the GDP deflator were 110.2? ($6,929/$9,628/$6,928). [$6,947/126.1 x 100 = $5,509 trillion [$7,636 trillion/110.2 x 100 = $6,929 trillion] “Nominal” “Real”

6. Unemployment 5,655,000 Unemployment Rate = Labor Force x 100; 4.0% = 140,863,000 x 100 [Employed + unemployed] [135,208,000+5,655,000] [Employed + unemployed] [135,208,000+5,655,000] I n Forney, 42 are unemployed & 658 are employed. T he unemployment r ate is __ %. One mil. are unemployed & 19 mil. are employed. The unemploy. rate is __%. 6 5 280 million, civilian labor force 1. If the total population is 280 million, and the civilian labor force 129,558,000 with jobs and 6,739,000 unemployed includes 129,558,000 with jobs and 6,739,000 unemployed but employment rate looking for jobs, then the employment rate would be ____%. 4.9 [6,739,000/136,297,000 x 100 = 4.9%]

7. And if it were $200 billion Unemployment [Let’s say that Nominal GDP is $100 billion.] [And if it were $200 billion?] Rate 1. 7%; real unemployment is __%; % gap is ___ %; output forgone is ___ bil. 2. 8%; real unemployment is __%; % gap is ___ %; output forgone is ___ bil. 3. 13%; real u nemployment is __%; % gap is ___ %; output forgone is ___ bil. 4. 14%; real u nemployment is __%; % gap is ___ %; output forgone is ___ bil. 6%Y*FYPYA $10 tr. $10 tr. [Frictional+Structural] 3 % 3 % AD 1 AS Arthur Okun GDP Gap unemployment rate over 6% x 2 [ GDP Gap = unemployment rate over 6% x 2] E2 Recessionary Gap(YR) Potential output ($10)exceedsactual output($9). Potential output ($10) exceeds actual output($9). Actual unemploy. rate (11%)exceedsPotential unemp. rate( 6% ). Actual unemploy. rate (11%) exceeds Potential unemp. rate( 6% ). 11%YRYA $9 Tr. $9 Tr. 1% AD 2 5% Cyclical(“real”) Unempl. 10%[5%x2=10%] Negative Gap [Okun’s Law] 1 22 2 44 7 14 14 816 16 FE GDP “Bull’s Eye”

8. 166.6 in 1999172.2 in 2000 1.The CPI was 166.6 in 1999 and 172.2 in 2000. Therefore, the rate of inflation for 2000 was (2.7/3.4/4.2)% CPI falls from 160 to 149 2. If the CPI falls from 160 to 149 in a particular year, the economy has experienced (inflation/deflation) of (5/-4.9/-6.9)%. 160.5 to 163.0 3. If CPI rises from 160.5 to 163.0 in a particular year, the rate of inflation for that year is (1.6/2.0/4.0)%. [-11/160 x 100 = -6.9%] (2006-later year) (2005-earlier year) (2006-later year) (2005-earlier year) Current year’s index – last year’s index 199.1 – 192.7 [6.7] Current year’s index – last year’s index 199.1 – 192.7 [6.7] C.P.I. = Last year’s index(2006-earlier year) x 100; 192.7 x100 = 3.3% 130.7-124.0(6.7) 116-120(-4) 333-300(33) 130.7-124.0(6.7) 116-120(-4) 333-300(33) 124.0 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____ 124.0 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____ [Change/Original X 100 = inflation]5.4% -3.3% 11% [5.6/166.6 x 100 = 3.4%] So, 3.3% increase in Social Security benefits for 2007

9. Consumers in this economy buy only two goods–hot dogs & hamburgers. Step 1. Fix the basket. What percent of income is spent on each. Consumers in this economy buy a basket of: 4 hot dogs and 2 hamburgers Step 2. Find the prices of each good in each year. YearPrice of Hot DogsPrice of Hamburgers 2001 $1$2 2001 $1$2 2002 $2 $3 2002 $2 $3 Step 3. Compute the basket cost for each year. 2001 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $8 2002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $14 2002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $14 Step 4. Choose one year as a base year (2001) and compute the CPI 2001 ($8/$8) x 100 = 100 2002 (14/$8) x 100 = 175 2002 (14/$8) x 100 = 175 Step 5. Use the CPI to compute the inflation rate from previous year (175-100)/100 x 100 =75% 2002 (175/100 x 100 = 175%) or to get actual % (175-100)/100 x 100 =75% Or, Change $14-$8 ($6) Original $8 x 100 = 75% Original $8 x 100 = 75%

10. (42%) buys the following quantities of these (42%) 18. Suppose that a typical consumer buys the following quantities of these three commodities in 2000 and 2001 three commodities in 2000 and 2001. CommodityQuantity2000 perUnit Price2001 perUnit Price CommodityQuantity2000 per Unit Price2001 per Unit Price Food5 units $6.00 $5.00 Clothing2 units $7.00 $9.00 Shelter3 units $12.00$19.00 concluded about the CPI for this individual from Which of the following can be concluded about the CPI for this individual from 2000 to 2001 2000 to 2001? a. It remained unchanged.c. it decreased by 20% b. It decreased by 25%.d. It increased by 20% e. It increased by 25%.(Answer) Year 1 [2000]: [5 food x $6 = $30; 2 clothing x $7 = $14; 3 shelters x $12 = $36, for dollar value of $80. CPI = 100 ($80/$80 x 100 = 100 for 2000)] Year 2 [2001]: [5 food x $5 = $25; 2 clothing x $9 = $18; 3 shelters x $19 = $57, for dollar value of $100. CPI =125 Change $100-$80 [$20] Original = $80 x 100 = 25%; so the CPI for this individual is 25%.

11. __________________________ “Rule of 70” “Rule of 70” = % annual rate of increase (3%) = 23 years Inflation [Inflation (prices to double)] Investments 70 70 70 [Investments to double] GDP 10 = ______ 12 = _____ 9 = _____ [GDP (standard of living) to double] 7 years 6 years 8 years 70 70

12. NominalIncome RealIncome InflationPremium - 16% 10 % 6%6%6%6% [ Nominal income – inflation rate = Real Income] =

13. 1 1 APC=C/Y APC = C/Y(DI)=$48,000/$50,000 =.96 APC = C/Y(DI)=$48,000/$50,000 =.96 APS = S/Y(DI)= $2,000/$50,000 =.04 APS = S/Y(DI)= $2,000/$50,000 =.04 APC = C/Y=$52,000/$50,000 = 1.04 APC = C/Y=$52,000/$50,000 = 1.04 APS = S/Y= -$2,000/$50,000 = -.04 APS = S/Y= -$2,000/$50,000 = -.04 APC - percentage of income (“Y”) consumed. APC - percentage of income (“Y”) consumed. AE=GDP “High maintenance Econ teacher” APS – percentage of income (“Y”) saved. APS – percentage of income (“Y”) saved. “Econ,Econ,APS=S/Y APC and APS What in the world is AE?

14. MPC, MPS, & the M ultiplier MPC, MPS, & the M ultiplier * The M E is the reciprocal of the MPS. “ M E ” The “ M E ” works like a concentric circle. MPC - % change in Y consumed. MPS - % change in Y saved. MPC = C/ Y = $750/$1,000 =.75 MPS = S/ Y = $250/$1,000 =.25 M ultiplier [1/MPS] =1/.25=$1/.25 = “M E ” of 4 [MPC is important for G in policy making decisions.] M E = 1/MPS $20 billion “G” [with ME of 4] 15 bil. 11.25 bil. 8.5 bil.

15. MPC 1/MPS = M E.901/.10= 10.801/.20= 5.751/.25= 4.601/.40= 2.5.501/.50= 2 MEMEMEME

16. MPC - MPC/MPS = M T.90-MPC/.10= -9.80-MPC/.20= -4.75 - MPC/.25= -3.60 - MPC/.40= -1.5.50 - MPC/.50 = - 1.50 - MPC/.50 = - 1 When the G gives a tax cut, the M T is smaller than the M E because a fraction [ MPS ] is saved and only the MPC is initially spent. So, the M T = - MPC/MPS. MTMTMTMT

17. The M E, M T, & M BB Multipliers M E [ C, Ig, G, or Xn] = 1/MPS = 1/.25 = 4 G increase of $20 bil.incr Y by $80 bil.$20x4=$80 So, G increase of $20 bil. will incr Y by $80 bil. [$20x4=$80] G decrease of $20 bil.decrease Y by $80 bil. - $20x4= - $80 bil. And a G decrease of $20 bil. will decrease Y by $80 bil. [ - $20x4= - $80 bil.] M T = - MPC/MPS = -. 75/.25 = -3 T decreaseof $20 bil.incr Y by $60 bil.-$20x-3=$60 So, T decrease of $20 bil. will incr Y by $60 bil.[-$20x-3=$60] T increase of $20 bil. decr Y by $60 bil.$20x-3= - $60 And a T increase of $20 bil. will decr Y by $60 bil. [$20x-3= - $60] M BB = 1 X ( G ) increase in G&T of $20 bil.incr Y by $20 bil.1X$20= $20 So, an increase in G&T of $20 bil. will incr Y by $20 bil. [1X$20= $20 ] decrease in G&T of $20 bil.decr Y by $20 bil.1X-$20= - $20 A nd a decrease in G&T of $20 bil. will decr Y by $20 bil.[1X-$20= - $20] increase in expenditures x theM will increase GDP Any increase in expenditures x the M will increase GDP. decrease in expenditures x the M will decrease GDP Any decrease in expenditures x the M will decrease GDP.

18. RR Excess Reserves Total (Actual) Reserves PMC = M x ER, so 10 x.90 =$9 TMS = PMC[$9] + DD[$1] = $10 [ MS = Currency + DD of Public ] Dennis Rodman deposits $1 with A 10% RR 10. 10 90 cents One Dollar One bank’s loan becomes another bank’s DD. Rodman’s

19. Excess Reserves Total(Actual) Reserves PMC = M x ER, so 10 x $1 = $10 TMS [$10] = PMC[$10] [ MS = Currency + DD of Public ] Rodman’s Bank Borrows $1 From The Fed [10% RR] RR One Dollar Rodman’s Bank 0 One Dollar One Dollar Fed

20. MULTIPLE DEPOSIT EXPANSION PROCESS RR= 20% Bank Acquired reserves and deposits RequiredreservesExcessreserves Amount bank can lend - New money created ABCDEFGHIJKLMN Other banks $100.00 80.00 80.00 64.00 64.00 51.20 51.20 40.96 40.96 32.77 32.77 26.22 26.22 20.98 20.98 16.78 16.78 13.42 13.42 10.74 10.74 8.59 8.59 6.87 6.87 5.50 5.50 21.97 21.97$20.00 16.00 16.00 12.80 12.80 10.24 10.24 8.19 8.19 6.55 6.55 5.24 5.24 4.20 4.20 3.36 3.36 2.68 2.68 2.15 2.15 1.72 1.72 1.37 1.37 1.10 1.10 4.40 4.40$80.00 64.00 64.00 51.20 51.20 40.96 40.96 32.77 32.77 26.22 26.22 20.98 20.98 16.78 16.78 13.42 13.42 10.74 10.74 8.59 8.59 6.87 6.87 5.50 5.50 4.40 4.40 17.57 17.57$80.00 64.00 64.00 51.20 51.20 40.96 40.96 32.77 32.77 26.22 26.22 20.98 20.98 16.78 16.78 13.42 13.42 10.74 10.74 8.59 8.59 6.87 6.87 5.50 5.50 4.40 4.40 17.57 17.57 $400.00 PM C P M C in the banking system [ MxER] TMS = $500.00 1 st 10 $ 357 ofthe$400 Paris Hilton Susie RahRah Ronald McDonald Reese Witherspoon I’m doing the econ rap.

22. More or better resources or better technology G CAPITALGOODS unemploymentrecession 40. At what letter is there unemployment [recession]? 41. What letters represent resources being used in their most productive manner most productive manner? [full employment, full production, and best available technology] improvement in technology 42. What letter represents an improvement in technology, new PPC therefore a new PPC frontier line? “law of increasing cost”? 43. The (straight line/curve) illustrates the “law of increasing cost”? “law of constant cost.” 44. The (straight line/curve) illustrates the “law of constant cost.” most economic growth in 45. At what letter would there be the most economic growth in the future the future if a country were producing there now? opportunity cost“C” to “D”; 46. What is the opportunity cost when moving from “C” to “D”; when moving fromE to B when moving from E to B; do we have to give anything upF to D & do we have to give anything up when moving from F to D? F A,B,C,D,E G A Capital Consumer noAB C D E F Consumer Goods

24. Y50 $’s looking for Y The Market for Dollars Quantity of Dollars Yen Price of Dollar 0 Y100 P QEQE S$S$S$S$ D1$D1$D1$D1$ Exchange Rate: $1 = ¥100 D A A D Appreciation of the Dollar Increase in taste for U.S. goods Increase in U.S. Interest Rates Decrease in U.S. Price Level Decrease in U.S. Growth Rate Depreciation of Dollar Decrease in Taste Decrease in I n. Rates Increase Price Level Increase Growth Rate D2D2D2D2 Y150 E1E1E1E1 E2E2E2E2 E3E3E3E3 Decrease in U.S. Currency Price Increase in Currency Price D3D3D3D3 Yendepreciates Yenappreciates Y looking for $’s

25. Y50 Quantity of Dollars Yen Price of Dollar Y100 Y100 P rice $S$$S$ D1$D1$D1$D1$ [Exchange Rate: $1 = Y100 ] D A A D D2D2D2D2 Y150 E1E1E1E1 E2E2E2E2 E3E3E3E3 D3D3D3D3 Yendepreciates Yenappreciates Y looking for $’s Appreciation/Depreciation M X X M T aste [products/assets] I nterest R ates Price Level Growth Rate Currency Price Currency Price + - $’s looking for Y

27. Real Domestic Output PriceLevel [Production cost] AD PLe Ye SRAS [REP][REP][REP][REP] [CIG-X][CIG-X][CIG-X][CIG-X]

28. Real Domestic Output, GDP Price Level AD 1 [caused by “C+Ig+G+Xn”] SRAS AD 2 YRYRYRYR LRAS YFYFYFYF Increase in AD 1.Increase in Consumption 2.Increase in Investment 3.Increase in Gov. spending A. On military spending A. On military spending B. On the infrastructure B. On the infrastructure C. On health care C. On health care 4. Increase in Net exports [Xn] A. Dollar depreciates A. Dollar depreciates B. Trade partners Y’s rise B. Trade partners Y’s rise

29. Real Domestic Output, GDP Price Level AD 2 [caused by “C+Ig+G+Xn”] SRAS AD 1 YRYRYRYR LRAS YFYFYFYF Decrease in AD 1.Decrease in Consumption 2.Decrease in Investment 3.Decrease in Gov. spending A. On military spending A. On military spending B. On the infrastructure B. On the infrastructure C. On health care C. On health care 4. Decrease in N et exports [Xn] A. Dollar appreciates A. Dollar appreciates B. Trade partners Y’s fall B. Trade partners Y’s fall

30. RGDP PL AS 1 AS 2 [caused by “REP”] AD Increase in AS [“REP”] Resource Cost [domestic] a. More land, labor, a. More land, labor, capital & entrepreneurs capital & entrepreneurs b. # of sellers increase b. # of sellers increase Resource Cost [overseas] Resource Cost [overseas] c. Imported inputs decrease in price c. Imported inputs decrease in price d. Dollar appreciates d. Dollar appreciates Environment [legal-institutional] a. Increase in subsidies a. Increase in subsidies b. Decrease in bus. regulations b. Decrease in bus. regulations c. *Decrease in business taxes c. *Decrease in business taxes Productivity Increase in productivity Increase in productivity

31. RGDP PL AS 1 AS 3 [caused by “REP”] AD Decrease in AS [“REP”] Resource Cost [domestic] a. Land, labor, & capital a. Land, labor, & capital become more scarce become more scarce b. N umber of sellers decrease Resource Cost [overseas] Resource Cost [overseas] c. Imported inputs increase in price in price d. Dollar depreciates E nvironment [legal-institutional] a. Decrease in subsidies a. Decrease in subsidies b. I ncrease in bus. regulations c. *I ncrease in business taxes Productivity Decrease in productivity

32. AD PL 1 AQD 1 Inverse [ Inverse ] PL AQD AQD 2 PL 2

33. ASASASAS PL 1 AQ S 1 DIRECT [ DIRECT ] AQ S 2 PL 2

34. “Non price Level” CI g GX n 1. “Non price Level” change-either C, I g, G, or X n “Whole AD curve” shifts 2. “Whole AD curve” shifts [There is a change in AQD but it is not caused by a change in price level.] Consumption Consumption Mariah Carey Concert G IgIgIgIg Chevy Ferrari XNXNXNXN [ Exports-Imports] CPL AQD 1 AD 2 AD 3 AD 1 RDO L et t here be m ore military weapons AQD 2 AQD 3

35. Change in A S Environment [Legal-institutional] REP 1. “N on price level c hange ”. Either R, E, or P 2. “Whole AS curve” shifts. 3. AQS changes but is not caused by a change in PL PL AQS 1 AQS 1 AS 3 AS 1 AS 2 1. Lower business taxes 2. Decrease in regulations 3. Increase in subsidies P Increase in P roductivity You save money. We don’t require dental or medical insurance. You don’t have to pay us a pension and we don’t take sick days. And – we can dance. AQS 2 AQS 3 Anything that lowers the cost of production will shift AS right. So – AS Shifters are REP AS Shifters(REP ) 1. Resource cost 2. Environment [legal-institutional environment for businesses change, environment for businesses change, affecting production costs affecting production costs [subsidies, bus. taxes, regulations] [subsidies, bus. taxes, regulations] 3. Productivity R Increase in the availability of R esources

37. Y R Y * Real GDP Y R Y * Real GDP PL AD 2 AD 1 LRAS Y R Y * Real GDP Y R Y * Real GDP SRAS PL S AE 1[C+Ig] AE[C+Ig+G] AE 2[C+Ig+G] 45o

38. PL AD 2 AD 1 LRAS Y * RGDP Y * RGDP SRAS PL S AE 1[C+Ig1] AE[C+Ig+G] AE 2[C+Ig2] Y * RGDP Y * RGDP YIYIYIYI YIYIYIYI Weaknesses [Limitations] of the AE Model Price Level ChangesDoes Not Show Price Level Changes Demand-Pull InflationDoes not show Demand-Pull Inflation Cost-Push Inflation [Stagflation]Does Not Deal With Cost-Push Inflation [Stagflation] premature demand-pullinflationIt ignores premature demand-pull inflation [Inflation just before FE GDP] “self-correction”It does not allow for “self-correction” 45o

39. [ increase 80] AE [ C + Ig ] AE [ C + Ig ] (billions of dollars) o 45 o C onsumption C + I g I g = $20 Billion Equilibrium 390 410 470 370 390 410 430 450 470 490 510 530 550 AE[C+Ig] [“ Basic ” or “ Simple ” economy] C =$450 Billion + 20 Ig +20 S GDP will increase by a “multiple” of 4 & that is why it is called the “multiplier”. Real GDP M ultiplier = 4 Private - Closed +60 more 370 390 450 470

40. o AE [C+Ig+Xn] AE [C+Ig+Xn] (billions of dollars) 45 o C onsumption C + Ig+Xn I g = $20 Billion Equilibrium Real domestic product, GDP (billions of dollars) 390470 370 390 410 430 450 470 490 510 530 550 450 20 1010 GDP [470] ) (C [450] + I g[20] +M [10] + X [10] = GDP [470] ) C = $450 Billion $530 510 490470450 430 410 S Private Open 390

41. AE (billions) o 45 oRGDP 390 470 Consumption C + I g + X n C + I g + X n + G Government Spending of $20 Billion $20 Billion Government Spending & Impact on Equilibrium Y S Mixed - Open Private-public - ROW $20 bil. on N ational D efense 550 Increases Y by $80 [$20 x 4 = $80] $390 $470 $550

42. -20 x 3 = -$60 Incr. T by $20 billion [MT = 3] Equilibrium GDP[-60] o 45 o Real domestic product, GDP (billions of dollars) $550 C + I g + X n + G C a + I g + X n + G $490 S Mixed-Open $20 bil. incr in T $490 $550 RGDP

44. Real Interest Rate, (percent) Quantity of Loanable Funds [*Use this graph if there is a chg in savings by consumers or chg in fiscal policy] [* Use the Money Market graph when there is a change in MS ] r=6%r=6%r=6%r=6% D1D1D1D1 F1F1F1F1 S balanced budget Starting from a balanced budget, if the G incr spendingdecr T G incr spending or decr T to get out of recession a recession, they would now be running deficitpushing a deficit and have to borrow, pushing up demand in the LFMincreasing up demand in the LFM and increasing the interest rate the interest rate. D2D2D2D2 r=8%r=8%r=8%r=8% F2F2F2F2 E1E1E1E1 E2E2E2E2 “real interest rate” Use the “real interest rate” with LFMlong-term LFM, because it is long-term. “nominal interest rate” Use “nominal interest rate” with money marketshort-term money market, as it is short-term. Borrowers Lenders $ 2 T G T Balanced Budget [G&T=$2 Tr.] $2.2 T $2 T $2 T

45. [*Use this graph if there is a chg in savings by consumers or chg in fiscal policy] [* Use the Money Market graph when there is a change in MS ] Real Interest Rate, (percent) Quantity of Loanable Funds r=6%r=6%r=6%r=6% D1D1D1D1 F1F1F1F1 S1S1S1S1 r=4%r=4%r=4%r=4% F2F2F2F2 E1E1E1E1 E2E2E2E2 Borrowers Lenders S2S2S2S2 The following would cause an increase in supply in the LFM and lower real interest rates: 1.Fed increases MS 2.HH save more 3.Business save more 4.Government saves more 5.Foreigners save more here

47. Real GDP PL SRAS AD 2 YRYRYRYR YFYFYFYF [Incr G; Decr T][ But we get negative Xn] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DIDIDIDICAD Y/Emp/PL; TLFM IRIRIRIR Start from a Balanced Budget G & T = $2 Trillion $2 tr. “I can’t get a job.” “N ow, this is better.” G T G T E1E1E1E1 E2E2E2E2 LRAS D1D1D1D1 D2D2D2D2S Loanable Funds Market r =6 % r =8 % Real In. Rate F1F1F1F1 F2F2F2F2 $2 tr. $2.2 tr. $2.2 $2.2 $1.8 $1.8

48. Y R DMDMDMDM Investment Demand Nominal Interest Rate 8 4 0 Money Market QID1 MS 1 AS AD 1 PL 1 8% 8% 6% 4% 0 MS 2 AD 2 PL 2 If there is a RECESSION MS will be increased. QID2 DIDIDIDI Y* Buy B onds MS I.R.QID AD Y / E mp/ PL Real GDP Buy E1E1E1E1 E2 6% Fed PL I want a job as a Rockette

49. $2 T tril. Real GDP PL SRAS AD 2 YIYIYIYI YFYFYFYF [Decr G; Incr T ] [Again, we get negative Xn] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DIDIDIDICAD Y/Emp/PL; TLFM IRIRIRIR Start from a Balanced Budget G & T = $2 Trillion $2 tril. G T G T [like we have “money trees”] E1E1E1E1 E2E2E2E2 LRAS Loanable Funds Market r =3 % r =6 % D1D1D1D1 D2D2D2D2 F1F1F1F1 F2F2F2F2 S $2.2 T tril. $1.8 tril.. $ 1.8 $2.2 $2.2 Real In. Rate

50. 10 8 6 0 If there is INFLATION, MS will be decreased. Y I Y/E mpl. /PL DIDIDIDI AD 1 PL DmDmDmDm Investment Demand Nominal Interest Rate 10 % 8% 6% 0 Money Market QID 2 AS AD 2 PL 2 MS 1 PL 1 MS 2 Sell QID 1 Y*Y*Y*Y* “It’s cheaper to burn money than wood.” SellBonds MSI.R. QID AD like “money trees” E1E1E1E1 E2E2E2E2 Fed

51. D m(K ) Keynesiansthe lower interest rate Also, the Keynesians don’t think the lower interest rate is as important as “profit expectations.” Y D Y * Investment Demand 7 % 5 % 1 % 0 Money Market QID 1 QID 2 SRAS AD 1 PL 7% 5 % 1 % 0 MS 2 D I(K) MS 1 K eynesian view D M isflat [liquidity trap during a depression] K eynesian view is that D M is flat [liquidity trap during a depression] is rathersteep not that strong and D I is rather steep so monetary policy is not that strong. Fiscal policy is “top banana.” Think “Great Depression” LRAS

52. 1% GDP Nominal Interest Rate 0 500 DmDmDmDm E MS 1 MS 2 Money Market PL SRAS AD Liquidity Trap stagnant economyinterest rates near or at zero Liquidity Trap – in a stagnant economy with interest rates near or at zero, an increase in MSrecession or depression gets worse increase in MS fails to stimulate AD, so recession or depression gets worse. people hoard their money. With low returns expected on financial investments, people hoard their money. Fiscal policy is needed here Banks are unwilling to lend in a slack economy. Fiscal policy is needed here. YDYDYDYD LRAS AD

53. D m(M) YrYrYrYr Investment Demand Money Market QID 1 SRAS AD 1 PL 1 i1i1i1i1 MS 2 D I(K) MS 1 Monetarist view D M is vertical [inelastic] Monetarist view is that D M is vertical [inelastic] and drop I.R. very much. D I is rather flat [elastic] very responsive D I is rather flat [elastic] so monetary policy is very responsive to decreases in the interest rate. LRAS 0 i2i2i2i2 i1i1i1i1 QID 2 Y*Y*Y*Y* Monetarist view economy is relatively stableincrease the Monetarist view is that the economy is relatively stable so increase the MS only as much as the increase in real GDPagainst fiscal policy MS only as much as the increase in real GDP. They are against fiscal policy “crowding out.” because of “crowding out.” PL 2 i2i2i2i2

55. 0 100 L Tax revenue (dollars) Tax rate (percent)

56. 0 100 M L Tax revenue (dollars) Tax rate (percent)

57. 0 100 M N L Tax revenue (dollars) Tax rate (percent)

58. 0 100 M M N L Tax revenue (dollars) Tax rate (%) MaximumTaxRevenue

60. 10% 3% 1% Annual Rate of Inflation 10 % PC 5% 5 % is Y * (F) with 3 % anticipated PL. 5 % is Y * (F) with 3 % anticipated PL. Menu of Choices “More inflation” “More inflation” or “more unemloyment” 3% Unemployment Inflat.Gap R ecess. Gap SRAS1 LRAS Y*5% AD 1 AD 2 PL 3% 10% Y I 3% Inflat.Gap AD 3 1% Y R 10 % Recess.Gap LRPC Alban William Housego Phillips 1914-1975 The SRPC is almost the mirror image of the SRAS curve. The new Phillips Curve will have a SRPC & a LRPC. SRPC

61. Annual rate of inflation Unemployment rate (percent) 7%6%5%5%4%3%2%2%1%7%6%5%5%4%3%2%2%1% 35 1 2 3 4 5 6 7 AS inflation declines AS inflation declines... U nemploy. increases PCPCPCPC

62. 3456 0 3% 6% 9% 12% 15% Annual Rate of Inflation (Percent) Unemployment Rate (Percent) LRPC SRPC 3 SRPC 2 SRPC 1 a1a1 b1b1 a2a2 a3a3 b2b2 b3b3 c3c3 c2c2 increase in AD movement up and to the left on the SRPC Remember, anytime there is an increase in AD, there is a movement up and to the left on the SRPC. SRAS curve shifts leftSRPC shifts right Remember, any time the SRAS curve shifts left the SRPC shifts right. decrease in AD movement down and to the right on the SRPC Also if there is a decrease in AD, there is a movement down and to the right on the SRPC. SRAS curve shifts right SRPC shifts left Also if the SRAS curve shifts right, the SRPC shifts left.

63. Inflation 15 % SRPC3SRPC3SRPC3SRPC3 SRPC1SRPC1SRPC1SRPC1 SRPC2SRPC2SRPC2SRPC2 There is a SRPC [output prices are changing] and a LRPC [output & input prices chg after unanticipated inflation or disinflation] LRPC LRPC - when unemployment = the natural rate and there is no tendency for PL to be incr/decr. PL is stable & contracts reflect it. inflation Let’s say that inflation averaged 9 % has averaged 9 % for the past few years. 9 % is anticipated 9 % is anticipated. 0 3 % 5 % 7 % My salary just isn’t keeping up. 12 % 9 % 6 % 3 % a1a1a1a1 a2a2a2a2 a3a3a3a3 b1b1b1b1 b2b2b2b2 b3b3b3b3 C1C1C1C1 c2c2c2c2 c3c3c3c3 LRPC Inflat.GapRecess.Gap Wow, my raise exceeds inflation. inflation Let’s say that inflation averaged 3 % has averaged 3 % for three 3 % is anticipated. years. 3 % is anticipated. But my salary went up by only 3%. It can’t get any better. My raise exceeds inflation. But when it comes time to sign a new contract, his boss says … But my raise was only 6%.