MACROECONOMICS FALL SEMESTER STUDY GUIDE Real GDP is the variable most commonly used to monitor short run changes in the economy because it is the most comprehensive measure of economic activity It measures the value of all final goods and services produced within a given time as well as total income adjusted for inflation When real GDP falls the rate of unemployment rises When studying the year to year changes in the economy monetary neutrality is no longer appropriate Real and nominal variables are highly intertwined and changes in the money supply can temporarily push real GDP away from its long run trend Aggregate demand curve Model of aggregate demand and aggregate supply model that most economists use to explain short run fluctuations in economic activity around its long run trend a curve that shows the quantitiy of goods and services that households firms the government and customers abroad want to buy at each price level goods and services that firms choose to produce at each price level a curve that shows the quantity of Aggregate supply curve the The demand curve is downward sloping because of o The wealth effect if price level falls then the dollars you are holding rise in value which increases your real wealth and your ability to buy goods and services A decrease in the price value encourages people to spend more o The interest rate effect As price level falls households try to reduce their holdings by lending money out Might use excess money to buy interest bearing bonds or deposit excess money into an interest bearing savings accounts As households convert money into interest bearing assets they drive down interest rates Lower interst rates make borrowing less expensive it encourages firms to borrow more to invest in new plants equipment and households to borrow more to invest in new housing A lower interest rate increases the quantity of goods and services demanded A lower price level reduces the interest rate encouraging greater spending on investment goods thereby increases the quantity of goods and services demanded o The Exchange Rate effect when a fall in the U S price level causes U S interest rates to fall the real value of the dollar declines in foreign exchange markets This depreciation stimulates U S net exports and thereby increases the quantity of goods and services demanded Why the Aggregate Demand curve might shift o Shifts airising from changes in consumption if people become more concerned about saving for retirement they might reduce their current consumption Then goods and services demanded at any price level would be lower and shift to the left If the economy booms people will become less concerned about saving and the quantity demanded at a given price will be higher so the curve will shift to the right When government cuts taxes it encourages peple to spend so the curve will shift to the right When taxes are raised people cut back on spending so the curve will shift to the left o Shifts arising from changes in investment if the computer industry comes out with a new line of fast computers firms will invest and the quantity demanded will be higher and the curve will shift to the right If firms become pessimistic about the future they will cut back on investing and shift the curve to the left An investment tax credit increases the quantity of investment goods that firms demand at any given interest rate and will shift the curve to the right The repeal of an investment tax credit will shift the curve to the left An increase in the money supply lowers the interest rate in the short run This decrease in the interest rate makes borrowing lest costly which stimulates investment spending and shifts the curve to the right A decrease in the money supply will raise the interest rate and discourage spending and move the curve to the left o Shifts arising from changes in government purchases If Congress decided to reduce purchases of new weapons systems the quantity demanded at the given price level is lower and would shift the curve to the left If state governments build more highways there is a greater quantity of goods demanded and the curve will shift to the right o Shifts arising from changes in net exports If Europe experiences a recession they will buy less American goods and reduce U S net exports at every price level and shift the curve to the left When Europe s economy gets better they will buy more goods and shift the curve to the right If other countries bid up the value of the U S dollar in the foreign exchange market the dollar will appreciate and U S goods become more expensive compared to foreign goods and the curve will shift to the left If the U S dollar depreciates the curve will shift to the left tells us the total quantity of The Aggregate Supply Curve goods and services that firms produce and sell at any given price In the long run the aggregate supply curve is vertical whereas in the short run the aggregate supply curve is upward sloping Why the aggregate supply curve is vertical in the long run In the long run an economy s production of goods and services its real GDP depends on its supplies of labor capital and natural resources and on the available technology used to turn these factors of production into goods and services Price level does not affect the long run determinants of real GDP so the curve is vertical In the long run labor capital resources etc determine the total quantity of goods and services supplied and the quantity supplied is the same regardless of what the price level happens to be Why the long run aggregate supply curve might shift o The long run level of production is sometimes called potential output of full employment output The natural rate of output shows what the economy produces when unemployment is at its natural or normal rate o Shifts arising from changes in labor increase in immigration leads to more workers which leads to an increase in goods and services supplied so the curve would shift to the right If American workers left to go abroad there would be a decrease in quantity supplied and the curve would shift to the left If Congress raised minimum wage the natural rate of unemployment would rise and the curve would shift to the left If government reformed the unemployment insurance system to encourage people to find jobs faster then unemployment would fall and the curve would shift to the right o Shifts arising from changes in capital increase in capital stock would increase productivity and then