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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 market will 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


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