Macroeconomics Final Study Guide Chapter 27 Aggregate Demand and Aggregate Supply Aggregate Demand Curve relationship between the aggregate price level and the quantity of aggregate output demanded by households businesses the government and the rest of the world Always sloping downward As you go down AD curve price level decreases and aggregate output increases wealth effect Wealth Effect higher aggregate price level reduces purchasing power and reduces consumer spending Interest rate effect higher aggregate price level reduces the purchasing power of households money holdings leading to a rise in interest rates and a fall in investment spending and consumer spending Why does the AD curve shift o Changes in expectation o Wealth o Stock of physical capital o Government policies What changes in expectations o Consumers and firms become more optimistic AD increases o Consumers and firms become more pessimistic AD decreases What changes in wealth do to AD o Value of household assets rises AD increase o Value of household assets falls AD decrease Increase in AD shifts curve to the right and decrease in AD shift curve to the left Stock of physical capital in regards to AD o Stock of physical capital is small AD will increase o Stock of physical capital is large AD will decrease Aggregate Supply Curve the relationship between the aggregate price level and the quantity of aggregate output in the economy Short run aggregate supply curve SRAS downward sloping o Movement down SRAS leads to deflation and low aggregate output Nominal wages dollar amount of wage paid Sticky wages nominal wages that slowly falll even in the face of high unemployment and slowly rise even in the face of labor shortages What shifts the SRAS o Commodity prices o Nominal wages o Productivity Changes in commodity prices o Commodity prices fall SRAS increase o Commodity prices rise SRAS decrease Changes in nominal wages o Nominal wages fall SRAS increase o Nominal wages rise SRAS decrease Changes in productivity o Production increases SRAS increase o Production decreases SRAS decrease Long Run Aggregate Supply Curve LRAS relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices including nominal wages were fully flexible o Fall or rise in aggregate price leave LRAS unchanged AS AD Model uses the aggregate supply curve and the aggregate demand curve together to analyze economic fluctuations Short Run Macroeconomic Equilibrium quantity of aggregate output supplied is equal to the quantity demanded Long Run Macroeconomic Equilibrium when the point of short run macroeconomic equilibrium is on the long run aggregate supply curve Gaps recessionary gap aggregate output is below potential output Inflationary gap aggregate output is above potential output Output gap actual aggregate output potential output Potential output Stabilization Policy use of government policy to reduce the severity of recessions and rein in excessively strong expansions Chapter 28 Fiscal Policy Fiscal Policy use of taxes government transfers or government purchases of goods and services to shift the aggregate demand curve GDP C I G x IM Expansionary and Contractionary Fiscal Policy Expansionary fiscal policy increases AD o leads to an increase in real GDP larger than the initial rise in aggregate spending caused by the policy o Make budget surplus smaller or budget deficit larger Contractionary fiscal policy decreases AD o leads to a fall in real GDP larger than the initial reduction in aggregate spending caused by the policy Multiplier Effect 1 1 MPC multiplier on changes in government purchases MPC 1 MPC multiplier on changes in taxes and transfers 1 1 MPC MPC 1 MPC Sgovernment T G TR Lump Sum Taxes taxes that don t depend on tax payers income Cycliclically adjusted budget balance estimate of the budget balance if the economy were at potential output The budget deficit as a percentage of GDP tends to rise during recessions and fall during expansions Fiscal Year October 1st September 30th Implicit Liabilities spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics Chapter 29 Money Banking and the Federal Reserve System Money any asset that can easily be used to purchase goods and services Currency in Circulation cash held by the public Checkable Bank Deposits bank accounts on which people can write checks Money Supply total value of financial assets in the economy that are considered money Medium of Exchange asset that individuals acquire for the purpose of trading rather than for their own consumption Store of Value means of holding purchasing power over time Unit of Account measure used to set prices and make economic calculations Commodity Money good used as a medium of exchange that has other uses Commodity Backed Money medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods Fiat Money medium of exchange whose value derives entirely from its official status as a means of payment Monetary Aggregate overall measure of the money supply Near Moneys financial assets that can t be directly used as a medium of exchange but can readily be converted into cash or checkable bank deposits M1 currency traveler s checks and checkable deposits M2 savings accounts that can easily and quickly be converted into M1 Financial Intermediary uses liquid assets in the form of bank deposits to finance the illiquid investments of borrowers T Account tool for analyzing a business s financial position by showing in a single table the business s assets and liabilities Bank Reserves currency banks hold in their vaults plus their deposits at the Federal Reserve Reserve Ratio fraction of bank deposits that a bank holds as reserves Loans and Reserves Assets Deposits Liabilities on T accounts Bank Run many of a bank s depositors try to withdraw their funds because of fears of a bank failure Deposit Insurance guarantees that a bank s depositors will be paid even if the bank can t come up with the funds up to a maximum amount per account Capital Requirements regulators require that the owners of banks hold substantially more assets than the value of bank deposits Reserve Requirements rules set by the Federal Reserve that determine the minimum reserve ratio for a bank Discount Window arrangement in which the Federal Reserve stands ready to lend money to