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FSU ECO 2013 - Chapter 9

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Chapter 9- Loanable funds market: The market that coordinates the borrowing and lending decisions of business firms and households- Demand for loanable funds:- Firms demand loanable funds (investment)- Downward sloping curve because as the interest rate decreases- Increase in investment: demand curve will shift right- Decrease in investment: demand curve will shift left- Supply of loanable funds:- Individuals supply loanable funds (through savings)- Upward sloping because as the interest rate increases people will want to save more- Increase in savings: supply curve will shift right- Decrease in savings: supply curve will shift left- Nominal interest rate: the percentage of the amount borrowed that must be paid to the lender in addition to the repayment of the principle- Real interest rate: the interest rate adjusted for inflation (real cost of borrowing and lending money)- How inflation affects borrowers and lenders:1. Actual Inflation > Anticipated Inflation: borrowers gain, lenders lose2. Actual Inflation < Anticipated Inflation: borrowers lose, lenders gain3. Inflation does not help borrowers or lenders in a systematic manner- Know that there is an inverse relationship between interest rates and bond prices:1. When the interest rate rises, the market value of previously issued bonds will fall2. When the interest rate falls, the market value of previously issued bonds will rise- The foreign exchange market: the market in which the currencies of different countries are bought and sold- The demand curve for foreign currency is downward sloping because as the dollar appreciates we can import more and invest more in other countries- Capital outflows: domestic money invested abroad- The supply curve is upward sloping because as the dollar depreciates, foreign countries invest domestically- Capital inflows: foreign money invested domestically- Equilibrium occurs when the supply of foreign currency equals the demand for foreign currency- Trade deficit: imports > exports- Trade surplus: exports > imports- Aggregate Demand (AD): The relationship between the price level and the quantity of domestically produced goods and services all households, business firms, governments and foreigners are willing to purchase- Downward sloping because as price level goes down, quantity demanded of all goods will increase- Short-Run Aggregate Supply (SRAS): Upward sloping because an increase in the price level will improve the profitability of the firms and cause them to increase output- Long-Run Aggregate Supply (LRAS): Vertical because in the long-run people have had time to adjust and so a higher price level will increase costs as much as it increases revenues - Short-run Equilibrium: Occurs at the intersection of the aggregate demand (AD) and short-run aggregate supply curve (SRAS)- Long-run equilibrium: Occurs where aggregate demand (AD), short-run aggregate supply (SRAS), and long-run aggregate supply (LRAS) all intersect at a single point.- In long-run equilibrium:- We have correctly anticipated the price level- There is no expansion or recession- Actual rate of unemployment is equal to the natural rate of unemploymentChapter 10- Shifters of Aggregate Demand (AD):- Changes in real wealth Increase in real wealth: shifts AD curve right Decrease in real wealth: shifts AD curve left- Changes in the real interest rate: The interest rate is inversely related to how much households consume and businesses invest Interest rate falls: shifts AD curve right Interest rate rises: shifts AD curve left- Changes in the expectations of businesses and households about the future Optimism: shifts AD curve right Pessimism: shifts AD curve left- Changes in the expected rate of inflation Expected increase in inflation: spend more now- AD curve shifts right Expected decrease in inflation: spend less now- AD curve shifts left- Changes in income abroad Foreign income increases: AD curve shifts right Foreign income decreases: AD curve shifts left- Changes in exchange rates Dollar depreciates: AD curve shifts right Dollar appreciates: AD curve shifts left- Shifters of Long-Run Aggregate Supply (LRAS):- Change in resource base- Change in level of technology- Change in institutional arrangements that affect productivity- Shifters of Short-Run Aggregate Supply (SRAS)- Changes in resource prices- Changes in the expected rate of inflation- Supply shocks- Know how to shift the aggregate demand / aggregate supply graph and how to identify the shift’s affect on equilibrium price level and output in both the short-run and the long-run.- Know the causes of recessions and expansions and how the economy can correct itself:- Permanent income hypothesis: Peoples consumption depends on their long-run expected permanent income rather than their current income People will: - save during expansions (spending increases only slightly)- spend savings during recessions (spending decreases only slightly)- Changes in real interest rates stabilize the economy Recession: less investment → low interest rates → higher consumption and investment (offsets recession) Expansion: more investment → high interest rates → lower consumption and investment (offsets expansion)- Changes in real resource prices stabilize the economy Recession: low demand → resource prices ↓ → SRAS to ↑. Expansion: high demand → resource prices ↑ → SRAS to ↓.Chapter 11- Basic differences between Classical and Keynesian Economics- Classical Economics: believes that market and resource prices are flexible and allow the economy to self-correct fairly quickly- Keynesian Economics: believe that market and resource prices are inflexible, and therefore, the marketwill not be able to quickly correct itself- Marginal propensity to consume (MPC): The amount of additional income that is consumed- MPC = additional consumption / additional income- The Expenditure Multiplier (M): A change in expenditures will have a greater impact than the initial change- M = 1 / 1- MPC - Budget deficits and surpluseso Balanced budget: government revenues (taxes) is equal to government expenditures T = G o Budget deficit: government spending is greater than government revenues T < Go Budget surplus: government revenue is greater than government spending  T > G- Fiscal Policy: Deliberate changes in tax policy and/or government expenditures designed to affect the budget deficit or surpluso Keynesian idea of using


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