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When to Shift Aggregate Demand = Consumer Spending + Business Investment + Government Spending + Net Exports AD = C + I + G + (X – IM) Aggregate Demand shifts to the left (AD1) when any of the four decrease due to: Decreased expectations of future income Decreased value of assets (wealth) Businesses have substantial inventory on hand Increased taxes Decreased government spending Decreased money supply Increased interest rates Aggregate Demand shifts to the right (AD2) when any of the four increase due to: Increased expectations of future income Increased value of assets (wealth) Businesses have little inventory on hand Decreased taxes Increased government spending Increased money supply Decreased interest rates Short-Run Aggregate Supply responds to changes in the price of inputs SRAS shifts to the left (not displayed) when the cost of inputs increase due to: Increased commodity prices (such as oil) Increased nominal wages economy-wide Decreased productivity SRAS shifts to the right (SRAS1) when the cost of inputs decrease due to: Decreased commodity prices (such as oil) Decreased nominal wages economy-wide Increased productivity LRAS shifts to the right (LRAS) when there is growth over time as a result of: Increased quality or quantity of resources Increased human capital Increased physical capital Improvements in technology For almost all questions, you will only need to shift one curve (AD, SRAS, or LRAS) at a time. Many mistakes on unit exams were made by shifting two curves simultaneously. When to Shift Money Demand is depicted here as a curve, though it may be represented as a line. Quantity of money demanded decreases as interest rates increase, which explains the downward slope of MD curve. Money Demand shifts to the right when: Aggregate price level increases Real GDP increases Banking laws make it advantageous to hold money on hand Money Demand shifts to the left when: Aggregate price level decreases Real GDP decreases Banking laws make it less advantageous to hold money on hand Changes in banking technology allows increased access to deposits, making it less necessary to hold money on hand Money Supply is set by the Federal Reserve through the use of its three tools (and the Money Multiplier effect). Money Supply shifts to the right in response to expansionary monetary policy, including: The discount rate is reduced The reserve requirement is reduced The Fed buys bonds Money Supply shifts to the left in response to contractionary monetary policy, including: The discount rate is raised The reserve requirement is raised The Fed sells bonds NOTE: Interest rates increase when money supply decreases. Interest rates decrease when money supply increases. This is why use of expansionary monetary policy offsets the “crowding-out effect.” When to Shift Production Possibilities Curve Loanable Funds Demand shifts to the right when: Government borrowing increases Private investment increases, often as the result of perceived business opportunities Loanable Funds Demand shifts to the left when: Government borrowing decreases Private investment decreases Loanable Funds Supply shifts to the right when: Private individuals and firms save more money, making more deposits available for banks to loan Capital inflows increase Loanable Funds Supply shifts to the left when: Private individuals and firms save less money, making fewer deposits available for banks to loan Capital inflows decrease REMEMBER: An increase in loanable funds demand in response to government borrowing raises interest rates, thus limiting private investment borrowing. This is the “crowding-out effect.” PPC shifts as a result of long-run growth or contraction of an economy – in the same way as the LRAS curve, and due to the same factors: Quality or quantity of resources Human capital Physical capital Technology Points on the graph reflect short-run decisions regarding allocation of resources. Short-run decisions that favor capital goods over consumer goods lead to long-run growth; however, BOTH capital and consumer goods must be produced within an economy. Short-run unemployment shows up as a point on or inside the graph. A point outside the graph represents a level of production beyond what is actually possible given current resources. When to Shift Foreign Exchange Market Demand for Currency shifts to the right when: The economy is growing rapidly Government policy/economic conditions raise the interest rate Foreigners want to loan funds in the domestic market An economy’s exports increase A country’s currency is devalued (through government action) or depreciates Demand for Currency shifts to the left when: A country’s trading partner(s) experience economic hardship Government policy/economic conditions lower the interest rate An economy’s exports decrease A country’s currency is revalued (through government action) or appreciates The key to FOREX is knowing which currency the question is asking about and creating the right model. Because every transaction has an effect in two different markets, you may need two graphs to represent a single transaction. Supply of Currency shifts to the right when: Individuals and firms exchange their local currency in order to purchase from or loan funds in another country Government policy increases the amount of currency available (i.e., increasing their foreign currency reserves by exchanging the local currency for foreign currency) Supply of Currency shifts to the left when: Individuals and firms reduce purchases from and loans to another country Government policy decreases the amount of currency available (i.e., buying up local currency using foreign currency reserves) For instance, the graph above shows the market for U.S. dollars in terms of yen. If you were asked what effect an action would have on the value of yen, you could not use this model. You would need to draw a new model to measure the value of yen in terms of U.S. dollars as well as the quantity of yen trading.