Abraham's AP MacroEconomics Blog

UNIT 4 - MONETARY POLICY Uses of Money Medium of exchange Unit of account Store of value Store of Value Is this really a dollar? Is this actually worth a dollar? If you have money in an account and money in storage, are they the same value? No, because banks draw interest Types of Money Commodity money Gold, silver significant economic value Representative money IOUs Fiat money Characteristics of money Durability Cutting a dollar in half, going to the bank to exchange it Portability Divisibility Uniformity Scarcity Acceptability  Money Supply M1 Money Cash Coins Currency Traveler's checks (cheques) Demand or checkable deposits Checkable deposits are the largest component of M1 M2 Money M1 + savings accounts M3 Money M2 + money market accounts + CD's MMA = An account that grows interest CD = certificate of deposit: people deposit money to bank, interest grows, bank gives money back to you + interest Liquidity

AGGREGATE DEMAND CURVE Aggregate demand curves down. Y axis: Price Level X axis: Real GDP AD is the demand by consumers, businesses, government, and foreign countries.  Changes in price level cause a move along the curve, not a shift of the curve. Formula: AD = C + Ig + G + Xn AGGREGATE DEMAND (AD) Shows the amount of Real GDP that the private, public, and foreign sector collectively desire to purchase at each possible price level. The relationship between the price level and the level of Real GDP is inverse. 3 reasons why AD is downward sloping Wealth Effect Higher prices reduce the purchasing power of $. This decreases the quantity of expenditures. Lower price levels increase purchasing power and increase expenditures. Ex. If the balance in your bank account was $50,000, but inflation erodes your purchasing power, you will likely reduce your spending. So... Price Level goes up, GDP demanded goes down.  Interest - Rate Effect As price level increases, lenders

THE AD/AS MODEL The equilibrium of AD and AS determines the current output (REAL GDP) and the price level (PL) Full Employment Full employment equilibrium exists where AD intersects SRAS and LRAS at the same point. Recessionary Gap A recessionary gap exists when equilibrium occurs below full employment output. Inflationary Gap  An inflationary gap exists when equilibrium occurs beyond full employment output. CHANGES (𝚫) in AD CHANGES in SRAS INCREASE DECREASE THREE RANGES  Horizontal or Keynesian Range: A lot of unemployed resources which creates a recession or depression.  Includes only levels of real GDP that are less than the full employment output. Intermediate Range: Resources are getting closer to the full employment level, which creates pressure on wages and prices. Vertical/Classical Range: Where real GDP is at a level with unemployment at the full employment level, and where any increase in demand will result only in an

Fiscal Policy Expansionary and contractionary policy Deficits and Surpluses Built-in-Stability Changes in the expenditures or tax revenues of the federal government 2 tools of fiscal policy Taxes - government can increase or decrease taxes Spending - government can increase or decrease spending Taxes and spending have an inverse relationship Fiscal policy is enacted to promote our nation's economic goals: full employment, price stability, and economic growth Deficits, Surpluses, and Debt Balanced budget Revenues = Expenditures Budget deficit Revenues < Expenditures Budget Surplus Revenues > Expenditures Government debt Sum of all deficits - sum of all surpluses Government must borrow money when it runs a budget deficit Government borrows from: Individuals Corporations Financial institutions Foreign entities or foreign governments Fiscal Policy Two Options Discretionary Fiscal Policy (action) Expansionary fiscal policy - think

Disposable Income (DI) Income after taxes or net income DI = Gross Income - Taxes 2 Choices With disposable income, households can either Consume (spend money on goods and dervices) Save (not spend money on goods and services) Consumption Household spending The ability to consume is constrained by The amount of disposable income The propensity to save Do housholds consume if DI = 0? Autonomous consumption Dissaving Saving Household NOT spending The ability to save is constrained by  The amount of disposable income The propensity to consume Do households save if DI = 0?  NO APC & APS Average propensity to consume/save APC + APS = 1 1 - APC = APS 1 - APS = APC APC >1 .: Dissaving -APS .: Dissaving MPC & MPS Marginal propensity to consume 𝚫C/𝚫DI % of every extra follar earned that is spent Marginal propensity to save 𝚫S/𝚫DI % of every extra dollar earned that is saved MPC + MPS = 1 1 - MPC = MPS

Investment is money spent or expenditures on: New plants (factories) Capital equipment (machinery) Technology (hardware & software) New homes Inventories (goods sold by producers) Expected Rates of Return How does business make investment decisions?  Cost/Benefits Analysis How does business determine the benefits?  Expected rate of return How does business count the cost?  Interest costs How does business determine the amount of investment they undertake? Compare expected rate of return to interest cost If expected return > interest cost, then invest If expected return < interest cost, then do not invest Real (r%) vs. Nominal (i%) What's the difference?  Nominal is the observable rate of interest. Real subtracts out inflation (𝜋%) and is only known ex post factor. How do you compute the real interest rate? r% = i% - 𝜋% What then, determines the cost of an investment decision? The real interest rate r% Investment Dem

AGGREGATE SUPPLY The level of Real GDP  Long Run v. Short Run Long Run Period of time where input prices are completely flexible and adjust to changes in the price level. In the long run, the level of Real GDP supplied is independent of the price level. Short Run Period of time where input prices are sticky and do not adjust to changes in the price level. In the short run, the level of Real GDP supplied is directly related to the price level. LONG RUN AGGREGATE SUPPLY (LRAS) The Long Run Aggregate Supply or LRAS marks the level of full employment in the economy (This is similar to that of PPC) SHORT RUN AGGREGATE SUPPLY (SRAS) Because input prices are sticky in the short run, the SRAS is upward sloping.  Changes in SRAS An increase in SRAS is seen as a shift to the right.  A decrease in SRAS is seen as a shift to the left.  The key to understanding shifts in SRAS is per unit cost of production. Formula: Per-unit production cost =