ECO 3223 SP2012 EVANS STUDY GUIDE FOR FINAL EXAM Note This is intended to direct you to the relevant topics that will be covered on the exam Questions will be worded differently so don t MEMORIZE this content use it to help you understand the concepts KNOW ALL OF THE KEY TERMS FROM EACH CHAPTER CHAPTER 3 WHAT IS MONEY 1 We discussed at length the evolution of money over time from commodity money to currency backed by gold to fiat money What is fiat money Fiat Money Paper currency decreed by governments as legal tender meaning that legally it must it must be accepted as payment for debts but not convertible into coins or precious metal page 57 2 What are the components of M1 and M2 What two factors make it so difficult for the central bank to know the true money supply from month to month M1 The narrowest measure of money that the Fed reports includes the most liquid assets Currency held in cash and coins by nonbank public excludes ATM and vault cash Checking account deposits Traveler s checks M2 Money aggregate that adds assets to M1 that are not quite as liquid as M1 M1 plus Small denomination time deposits Savings deposits and money market deposit accounts Money market mutual fund shares retail PAGE 65 A problem in the measurement of money is that the data are not always as accurate as we would like Substantial revisions in the data are not a reliable guide to short run say month to month movements in the money supply although they are more reliable over longer periods of time such as a year CHAPTER 22 AGGREGATE DEMAND and SUPPLY ANALYSIS 1 The AD AS SRAS Model You need to know the following a AD Curve What relationship does it express What are its components What shifts the AD curve Page 565 Aggregate demand the total quantity of an economy s final goods and services that firms in the economy want to sell at different price levels 1 Aggregate demand curve Describes the relationship between the quantity of aggregate output demanded and the price level when all other variables are held constant Made up of 4 components 1 Consumer expenditure total demand for consumer goods and services 2 Planned investment spending total planned spending by business firms on new machines factories and other capital goods plus planned spending on new homes 3 Government spending spending by all levels of government federal state and local on goods and services 4 Net exports the net foreign spending on domestic goods and services equal to exports minus imports What shifts the AD CURVE See chart on Page 569 Money supply An Increase in Ms AD Curve shifts to the RIGHT Government Spending An Increase in G AD shifts to RIGHT Taxes An Increase in Taxes AD shifts to LEFT Net Exports Increase in NX AD shifts to RIGHT Consumer Optimism Increase in C AD shifts to RIGHT Business Optimism Increase in I AD shifts to RIGHT b SRAS Curve What relationship does it express What shifts the SRAS curve The relationship between the quantity of output supplied and the price level in the SHORT RUN It exhibits sticky wages due to the assumption that wages and prices take time to adjust to economic conditions What shifts the SRAS curve Page 570 571 Production costs The SRAS curve shifts to the LEFT when costs of production increase and to the RIGHT when costs decrease Factors affecting production costs PAGE 571 572 Wage push Will increase production costs and shift SRAS to LEFT Positive supply shock Will decrease production costs and shift SRAS curve to RIGHT 2 Negative supply shock Will increase production costs and shift SRAS curve to LEFT c LRAS Curve What does it express What factors shift LRAS Page 570 575 Factors that shift the LRAS The relationship between the quantity of output supplied and the price level in the LONG RUN The LRAS curve reflects the lack of a cause and effect relation between real production and the price level As the price level rises real production remains constant at the full employment level Yn As the price level falls real production remains constant at the full employment level Due to flexible prices the same level of real production is generated at every price level d Construct an AD SRAS model in long run equilibrium See graphs on pages 576 577 2 Adjustment to Long Run Equilibrium Be able to demonstrate explain interpret a and employment Describe this mechanism and why it works the way it does How the economy adjusts to short run equilibrium that is above the natural rate of output Y short run equilibrium Yn Natural rate of full employment The aggregate supply curve shifts to the LEFT until output reaches the level of Yn by the Self correcting mechanism Regardless of where output is at initially it returns to the natural rate level See graph A in figure 5 on page 576 b and employment Describe this mechanism etc How the economy adjusts to short run equilibrium that is below the natural rate of output Y short run equilibrium Yn Natural rate of full employment The aggregate supply curve shifts to the RIGHT until output reaches the level of Yn by the self correcting mechanism figure 5 on page 576 See graph B in c that cause the economy to tend toward LRAS Discuss Adam Smith s Invisible Hand i e the self correcting mechanism and the variables The invisible hand theory is the self regulating mechanism of the economy Every person that is active in the economy does so for the benefit of themselves and themselves only Therefore by 3 looking out for one s own wealth a person puts in more effort to therefore profit as much as possible In a free economy the self correcting mechanism requires no government policy to restore economic equilibrium 3 Working with the AD SRAS Model Be able to draw and explain events like oil shocks aggregate demand shocks etc in both the short run and long run Why are the effects different Pages 577 578 The effects are different in the short run and long run because although the initial short run effect of the rightward shift in the aggregate demand curve demand shock is a rise in both the price level and output the ultimate long run effect is only a rise in the price level 4 Real Business Cycle Theory Explain its basic premise and how it addresses the natural rate of output and employment Page 579 A theory of aggregate economic fluctuations in which aggregate supply real shocks do affect the natural rate level of output Yn This theory views shocks to tastes workers willingness to work and technology productivity as the major driving forces behind short run fluctuations in