FINAL EXAM ECONFactors 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 GDPWhy does AD have a negative slope?- Wealth effect- Interest Rate effect- NX effectWealth 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 PLInterest Rate Effect- As the PL rises, we need more money to buy goods and services- Households hold more cash and borrow moreo The increase in demand for loans increases the real interest rates on loans, so consumption and investment both decreaseNet Export Effect- As PL rises faster in the US compared to the ROWo Exports decreaseo Imports increaseo So net exports decreaseLRAS- Identifies output at full potential (full employment)- Shiftso Change of resource base (input costs)o Change in number of workerso Change in the size of the capital stocko Technological advancement- EXAMPLE: How the internet effected the LRASo Output at potential shifts right because workers are more productiveSRAS- Is upward slopingo Input prices (wages are sticky)o As PL increases, the quantity of goods and services firms are willing tosupply increaseso Revenue-Cost=Profitso As demand increases, firms may not increase their prices due to menucosts Menu costs are the costs for firms to chance priceso A rising PL leads to a larger quantity of goods and services supplied- Shifts in SRASo An unexpected change in the input prices (oil)o Increase in the labor force and/or the capital stocko Technological change (Increases productivity)o An increase in the expected future PLo Workers and firms adjustment to errors in past expectations of PLo 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 equilibriumo 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 priceso If AD shifts right because of something like investment, SRAS will shiftleft 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 Cand I will cause a small increase of PL, but a huge decrease in output and employmentMonetary vs Fiscal Policy (BOTH CHANGE AD)- Monetary changes interest rates and investment- Fiscal policy changes taxes and government expendituresFirms are responsible for supply curve- Flexible wages and demand for their outputThe 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 Policieso 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 QUESTIONo 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 Operationso 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 iInflationary Situation- The Fed will sell bonds to decrease the amount of money in the economy- This will shift supply of loanable funds to the lefto This raises interest rates- With higher interest rates, consumption and investment decreaseo This is because people want to save more and spend less- This will shift AD to the