Econ 104 Final Study Guide Money Market is where financial instruments loans cash bonds are traded and equilibrium r is determined can be determined by changes in Y in the goods market as well Y increases MD increases r increases o Monetary Policies are used to change the level of interest rate MS Interest the price of money Transaction motive people need liquidity to buy things Money Demand is the relationship between interest rate and quantity of money Speculation Motive people want to buy bonds so their assets grow over time demanded negative relationship between r and QMD When aggregate output Y or price level P rise then MD shifts right The point where MD and MS intersect is the equilibrium interest rate o MS is a vertical line The Fed controls the MS shifts left right depending on the policy Expansionary easy loose and contractionary tight Production Sector Goods and Services market is where equilibrium Y is determined and fiscal policies are used to change the level of Y u and P AD C I G NX the total demand for goods and services in the economy Real Economy Market for Goods and Services the equilibrium level of output is determined by AD and AS Links between Goods Market Money Market o Production Income Y influences MD and r Y increases MD increases interest increases o r influences Investment I and Y r increases investment falls AD falls Y falls Investment Function when r falls I rises Fiscal Policy and Monetary policies variables G T MS o Expansionary policies are used to stimulate the economy o Expansionary Fiscal Policy increase in G or decrease in T aimed at increasing Income Y decreasing u o Expansionary Monetary Policy increase in MS aimed at increasing income Y decreasing u Can only be effective if I changes when r changes the effectiveness depends on the slope of the investment function more vertical the less ineffective o Contractionary policies are designed to contract the economy decreasing Y to stabilize prices reduce inflation Contractionary Fiscal Monetary Policies Decrease G increase T and decrease MS aimed at reducing inflation P Crowding out effect is when r increase investment decreases AE decreases Y decreases Ex Output Y increases less than it would have if MD had not increased AD curve shows the negative relationship between Y and P o When G T or MS policies change AD will shift o Expansionary policies shift AD to the right and Contractionary policies shift AD to the left AS curves in the SR has a positive slope o Low levels of aggregate output recession AS is flat Y will increase with little or not change in P o High levels of aggregate output boom AS is vertical When AD increase P increases and not Y Shift right in SR AS are caused by lower costs economic growth public policy good weather o Cost shock change in costs that shifts the AS curve AS curve in the LR is a vertical line that shows the potential natural level of output the economy can produce w o inflation also called the full employment output o For short periods of time the output can be pushed about AS LR by higher AD this will cause the overall price level to rise this puts upward pressure on costs and shifts the SR AS to the left Expansionary policies shifting AD work best when on the flat portion of the AS curve causing little change in P and higher increase in Y When AS curve is vertical neither monetary nor fiscal policies have an effect on Y Inflation is an increase in overall P Sustained inflation occurs when the overall P continues to rise over a long period of time 1970s Demand pull inflation is initiated by an increase in AD Cost push inflation is caused by an increase in production costs Stagflation occurs when Y is falling and P is rising at the same time one cause is increase in costs Hyperinflation is a period of very rapid increases in the price level ex Germany after WWII o Hyperinflation is corrected with the crowding out effect increase in G shifting AD leading the r to increase only happens on AS SR vertical o Fed tries to prevent crowding out by increasing MS the AD curve with continue shifting right resulting in sustained inflation