FINAL EXAM ECON Factors that effect AD Income taxes Business taxes Interest rates Government expenditures Household s expected future income Firms expectations of future profitability Strength of the dollar Relative growth of GDP Why does AD have a negative slope Wealth effect NX effect Interest Rate effect Wealth is equal to Assets Liabilites As PL rises wealth falls so consumption decreases and saving increases This would result in a shift along the AD curve because directly related to PL Interest Rate Effect As the PL rises we need more money to buy goods and services Households hold more cash and borrow more o The increase in demand for loans increases the real interest rates on loans so consumption and investment both decrease Net Export Effect As PL rises faster in the US compared to the ROW o Exports decrease o Imports increase o So net exports decrease LRAS Identifies output at full potential full employment Shifts o Change of resource base input costs o Change in number of workers o Change in the size of the capital stock o Technological advancement EXAMPLE How the internet effected the LRAS o Output at potential shifts right because workers are more productive SRAS Is upward sloping o Input prices wages are sticky o As PL increases the quantity of goods and services firms are willing to supply increases o Revenue Cost Profits o As demand increases firms may not increase their prices due to menu costs Menu costs are the costs for firms to chance prices o A rising PL leads to a larger quantity of goods and services supplied Shifts in SRAS o An unexpected change in the input prices oil o Increase in the labor force and or the capital stock o Technological change Increases productivity o An increase in the expected future PL o Workers and firms adjustment to errors in past expectations of PL o EXAMPLE A supply shock causing an increase of the price of oil Shifts SRAS to the left If economy stayed at PL of 100 there s a shortage PL must rise However since recession causes falling wages and lower PL the economy corrects itself and shifts back to equilibrium o If PL in US falls NX rise because products are cheaper to ROW o The internet also effected SRAS because PL decreased since productivity increase so the cost for firms decreased which means firms can offer more goods services at lower prices o If AD shifts right because of something like investment SRAS will shift left because wages are flexible causing same output at lower PL o If SRAS shifts left due to increase in oil prices a resulting decrease in C and I will cause a small increase of PL but a huge decrease in output and employment Monetary vs Fiscal Policy BOTH CHANGE AD Monetary changes interest rates and investment Fiscal policy changes taxes and government expenditures Firms are responsible for supply curve Flexible wages and demand for their output The FOMC Meeting December 17 18 They will look at U E CC RGDP and Fiscal Policy Their decisions will be made with respect to interest rates Different Policies o Conventional Lower short term interest rates Accelerate o Non conventional Lower long term interest rates REALLY accelerate o Tapering Letting up on the gas as economy gains momentum PROBABLY A TEST QUESTION o In its two day meeting in December the FOMC will be discussing how to signal that tapering does not mean that short term and long term interest rates will The Federal Reserve Open Market Operations o Recession Open Market Purchase of US Treasury bonds from public Bond sellers receive a check from the Fed which they can deposit at a local bank M1 supply increases o Inflation Open Market Sale Fed sells bonds to public public writes a check M1 supply decreases o DO NOT DIRECTLY CHANGE INTEREST RATES ONLY BUY SELL BONDS WHICH SHIFTS SUPPLY OF LOANABLE FUNDS LEFT RIGHT WHICH IMPACTS i Inflationary Situation The Fed will sell bonds to decrease the amount of money in the economy This will shift supply of loanable funds to the left o This raises interest rates With higher interest rates consumption and investment decrease o This is because people want to save more and spend less This will shift AD to the left