The market in which goods and services are exchanges and in which the equilibrium level of aggregate output is determined
fiscal policy
government spending and taxation
Y = C + I + G
money market
the market in which financial instruments are exchanged and in which the equilibrium level of interest rate is determined
monetary policy
the amount of money in the economy, interest rates
AE = planned aggregate expenditure
always equal to C + I + G
AE = Y
R lower = I ^ = AE ^ = Y ^
Interest rate is the money market, Investment, AE, and Y goods market
Y^ = Md ^ = R^
Expansionary fiscal policy
An increase in government spending or a reduction in net taxes aimed at increasing aggregate output
increases income
money demand
^ G = ^ Y = ^ Md = ^ r = lower I
interest rate and the investment change is unwanted, and is called the crowding out effect
can be fixed by the federal reserve. ” Fed accommodation ”
expansionary monetary policy
an increase in the money supply aimed at increasing aggregate output and thus bringing the interest rate back down
“easy monetary policy”
4 federal tools for expansionary policy
lower required reserve ration
lower the discount rate
lower the federal funds rate
buying bonds ( increasing money supply)
Contractionary policy
increase required reserve ratio
increase discount rate
increase FFR (overnight bank borrowing rate)
selling bonds ( removing money supply from the economy)
Aggregate demand curve
A curve that shows the negative relationship between aggregate output and the price level.
Each point on the AD curve is a point at which both the goods market and the money market are in equilibrium
why is the aggregate demand curve negative?
PL ^ = Md ^ = ^ r = lower investment
PL ^ = md ^ = ^ r = lower consumption
PL ^ = Purchasing power lower
Only shifts due to policy
expansion fiscal / monetary policy shifts to the right
contractionary policy shifts to the left
two links between goods market and money market
Y = C + I + G → Md
goods market affecting the money market
R → I ( interest rates affect the amount of investment)
money market affecting the goods market
IS-LM curve
Investment / Savings - Liquidity of Money Curve
x is aggregate output, y axis is interest rate
IS is negative, the lower interest rate, higher Y
LM is positive, higher interest rate, higher Y
Where they intersect is the equilibrium of goods and money market.
Chapter 13
Keynesian AS Curve
Y axis of price level
X axis of Aggregate output
exponential in the positive direction. starting out with slope ~ 0
Reasons for its shape
Wages lag behind price level changes
on the flat portion, the economy is not operating at full capacity. On the vertical slope, the economy is at full capacity
full capacity - economy reaches peak production and employment
What causes the Aggregate supply curve to shift
good weather / AS -⇒
increase in company input costs / ⇐- AS
energy prices increase / ⇐- AS
Technology development / AS -⇒
Tighter regulation / ⇐- AS
Expansionary policies work on the flatter, more recession indicative areas of the aggregate supply curve, because there is a large increase in aggregate output with a relatively small amount of PL increase.
Cost shock
a change in costs that shifts the short run aggregate costs
Demand pull inflation
inflation that is initiated by an increase in aggregate demand, when expansionary policy is done during the vertical portion of the keynesian supply curve. Expansionary during a peak.
Cost push / supply side inflation
with no change in monetary or fiscal policy, there is a shift in aggregate output in the aggregate supply curve.
The expansion fiscal policy, matched with expansionary monetary policy can cause a small increase in inflation. This cycle if not stopped causes a sustained, incessant inflation.
Chapter 14
Classical supply graph is completely vertical on the PL Y scale
Wages Y axis, Labor X axis. Supply for labor, demand for labor, from the firm perspective.
Sticky Wages
Wages stick at the original demand pay, but at now lower demand value, because people don’t want to get a job at a lower wage. This causes unemployment.
Relative wage explanation of unemployment
An explanation for sticky wages, if workers are concerned about their wages relative to other workers in other firms and industries they may be unwilling to accept a wage cut unless they know that all other workers are receiving similar cuts.
Cost of living adjustments
Contract provisions that tie wages to changes in the cost of living. The greater the inflation rate, the more wages are raised.
Efficiency wage theory
An explanation for unemployment that holds that the productivity of workers increases with the wage rate. If this is 0, firms may have incentive to pay wages above the market-clearing rate.
Phillips Curve
shows the relationship between the inflation rate and the unemployment rate.
PL ^ → lower Unemployment
Inverse relationship between inflation and unemployment
If there is anticipation for inflation, the curve shifts to the right. IF there is not, the curve shifts to the left.
broke down in the 70s and 80s during stagflation. Became completely unreliable.
No real relationship between Price level and unemployment