ECO 3223-SP2012 EVANSSTUDY GUIDE FOR FINAL EXAM Note: This is intended to direct you to the relevant topics that will be covered on the exam. Questions willbe worded differently, so don’t MEMORIZE this content; use it to help you understand the concepts. *KNOW ALL OF THE KEY TERMS FROM EACH CHAPTERCHAPTER 3: WHAT IS MONEY? 1. We discussed at length the evolution of “money” over time; from commodity money to currencybacked 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 bankto know the true money supply from month to month?M1- The narrowest measure of money that the Fed reports; includesthe 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 ANALYSIS1. 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 ADcurve?Page 565Aggregate demand- the total quantity of an economy’s final goods andservices that firms in the economy want to sell at different price levels.1Aggregate 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 services2. Planned investment spending- total planned spending by business firms on new machines; factories and other capital goods, plus planned spending on new homes3. Government spending- spending by all levels of government (federal, state, and local) on goods and services4. 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 570-571Production 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- The relationship between the quantity of output supplied and the price level in the LONG RUN.Factors that shift the LRASThe 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 576-5772. Adjustment to Long-Run Equilibrium: Be able to demonstrate/explain/interpreta. How the economy adjusts to short-run equilibrium that is above the natural rate of output and employment. Describe this mechanism and why it works the way it does.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. How the economy adjusts to short-run equilibrium that is below the natural rate of output and employment. Describe this mechanism, etc. 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. (See graph B infigure 5 on page 576)c. Discuss Adam Smith’s “Invisible Hand”, i.e., the self-correcting mechanism and the variablesthat cause the economy to tend toward LRAS.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 3looking 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 577-578The 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 level4. Real Business Cycle Theory: Explain its basic premise and how it addresses the natural rate of output and employment. Page 579A theory of aggregate economic fluctuations in which aggregate supply (real)