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Transcript
Aggregate Demand Curve – Putting It All Together Review: Aggregate Demand/Aggregate Supply Model AD Question: How many final goods and services would be purchased if the inflation rate () were _______ percent, given that all other factors relevant to demand remained the same? (%) AS AD Aggregate Demand (AD) curve is downward sloping G&S AS Question: How many final goods and services would be produced if the inflation rate () were _______ percent, given that all other factors relevant to supply remained the same? Aggregate Supply (AS) curve is upward sloping Equilibrium Goods and services (G&S) purchased AD C + I + G = = = Goods and services (G&S) produced AS GDP Notation: G&S = Final goods and services = Inflation rate i = Nominal interest rate r = Real interest rate Real Nominal Rate interest = interest of rate rate inflation r = i Question: Why Is the aggregate demand curve downward sloping? Fed’s Goal: Stabilize the Economy The Fed does so by using its throttle, the real interest rate. Taylor Principle: How the Federal Reserve Board (Fed) Stabilizes the Economy When the inflation rate () increases the Fed “slows down” the economy by increasing the real interest rate (r). Inflation rate () increases Real interest rate (r) increases Loans become more costly When the inflation rate () decreases the Fed “speeds up” the economy by decreasing the real interest rate (r). Taylor principle Households and firm purchase fewer goods and services In the entire economy fewer goods and services (G&S) purchased Economy “slows down” Inflation rate () decreases Real interest rate (r) decreases Loans become less costly Households and firm purchase more goods and services In the entire economy more goods and services (G&S) purchased Economy “speeds up” Economy stabilizes Taylor Principle and the Fed Policy (FP) Curve Taylor Principle When the inflation rate () increases the Fed “slows down” the economy by increasing the real interest rate (r). When the inflation rate () decreases the Fed “speeds up” the economy by decreasing the real interest rate (r). FP Question: What would the real interest rate (r) equal, if the inflation rate () were _______ percent, given that the Fed does not change its inflation policy? (%) FP The Fed policy (FP) curve is upward sloping to stabilize the economy. r (%) Deriving the Aggregate Demand (AD) Curve FP Question: What would the real interest rate (r) equal, if the inflation rate () were _______ percent, given that the Fed does not change its inflation policy? (%) AD Question: How many final goods and services would be purchased, if the inflation rate () were _______ percent, given that all other factors relevant to demand remained the same? (%) FP AD r (%) Fed increases Loans Households Fewer goods Inflation the real become and firms and services rate () interest rate (r) more costly purchase less purchased increases Taylor principle C and I AD = C + I + G (FP curve) decrease decreases Question: How does the Fed influence the real interest rate (r)? G&S To understand how the Fed affects the real interest rate (r) we study the money market. Money and Income Differ. Conceptual Definition of Money: The medium Operational Definition of Money: of exchange. The financial assets that you own M1 = Cash + Checking Deposits that can be used to purchase goods and services. M2 = M1 + Savings Deposits Income: How much you earn over the i (%) MS course of a year. The demand curve for Demand Curve for Money (MD): How money is downward much money would be demanded if the sloping nominal interest rate were ______, given that everything else relevant to the demand for money remains the same? The nominal interest (i) rate rises. Interest earning assets (CD’s, Treasury bonds, corporate bonds, etc.) become more attractive because they are earning more interest. Individuals seek to hold more interest earning assets. To hold more interest earning assets individuals hold less money. i* MD M Question: Why is the demand curve for money (MD) downward sloping? Question: Why is the supply curve for money (MS) vertical? Claim: The Fed controls the money supply. Question: How does the Fed control the money supply? Study the banking system Banking System Is the bank Yes Board Roles of the“loaned Federalup?” Reserve Liabilities Assets Fed MonitorsRequired Banks Required RES 50 DEP 500 = reserve Deposits Fed Acts as the Bank’s Bank reserves ratio Vault Cash 30 Fed Uses Its Policy Tools Dep at Fed 20 500 = Monetary 10% to Control the Money Supply SEC 60 = 50 Open market operations BOR 10 LOANS 480 Excess = (Actual) Required rate reservesDiscount reserves reserves Required Reserve Ratio = 10% Required reserve ratio = 50 50 = 0 Question: Which balance sheet entry constitutes Open market operation: money? That is, which entry can we use to The Fed purchases or sells Treasury purchase goods and services? Deposits. DEP bills (T-bills) that have been previously Increase the Decrease the operations Question: How do open market affect issued by the U.S. Treasury. money supply money supply the bank’s deposits? Key Questions to Pose Monetary Policy i (%) Decrease the reservesIncrease the and a required MS MS’ MS’ With actual of _______ money supply money supply reserve ratio of _______%, how many deposits can banks be liable for? _______ DEP decreases DEP increases Since loans and deposits increase by the same amount when a bank issues a new loan and reserves are unaffected, many ____________ MS curve MShow curve loans _________ shiftscan leftbanks issue? shifts right M Open Market Operation: Purchase of $5 Liabilities Assets With actual reserves of _______ 55 and a RES DEP 550 505 500 55 50 10 required reserve ratio of _______%, Vault Cash 30 how many deposits can banks be liable Dep at Fed 25 20 550 for? _______ SEC 60 Since loans and deposits increase by the BOR 10 525 480 same amount when a bank issues a new LOANS loan and reserves are unaffected, how Required Required more many ____________ loans should banks Deposits reserves = reserve ratio issue? _________ 45 T-Bill = 10% 550 500 = 55 50 Federal Reserve Board Washington, DC Kate Pay to the order of Kate Janet Yellen $5 Fed Bank’s deposits at its bank, the Fed, increase by $5. Kate’s deposits at his bank increase by $5. Kate’s Bank Open Market Operation: Purchase of $5 Bank deposits increase by 50 from 500 to 550 Money supply (MS) curve shifts right Nominal interest rate falls Liabilities Assets RES 55 50 Vault Cash 30 Dep at Fed 25 20 SEC 60 DEP 550 500 LOANS BOR 10 525 480 i (%) MS MS’ Lab 5.2 5.0 3.8 MD 500 550 M Open Market Operation: Sale of $5 With actual reserves of _______ 45 and a 10 required reserve ratio of _______%, how many deposits can banks be liable for? _______ 450 Liabilities Assets 45 50 RES Vault Cash 30 Dep at Fed 15 20 SEC 60 DEP 435 480 BOR Since loans and deposits increase by the same amount when a bank issues a new LOANS loan and reserves are unaffected, how fewer many ____________ loans should banks 45 issue? _________ 450 495 500 10 Required = Required reserve Deposits reserves ratio T-Bill = 10% 450 500 == 45 50 Kate Amherst, MA Kate Pay to the order of the Fed Kate $5 Fed Bank’s deposits at its bank, the Fed, decrease by $5. Kate’s deposits at her bank decrease by $5. Kate’s Bank Aside: Would reducing loans create a disruption at the bank? Open Market Operation: Sale of $5 Bank deposits decrease by 50 from 500 to 450 Money supply (MS) curve shifts left Nominal interest rate rises Lab 5.3 Liabilities Assets RES 45 50 Vault Cash 30 Dep at Fed 15 20 SEC 60 DEP 450 500 435 480 BOR 10 LOANS i (%) MS’ MS 6.3 5.0 MD 450 500 M Aggregate Supply Curves Aggregate Demand/Aggregate Supply Model AD Question: How many final goods and services would be purchased if the inflation rate () were _______ percent, given that all other factors relevant to demand remained the same? (%) AS AD Aggregate Demand (AD) curve is downward sloping G&S AS Question: How many final goods and services would be produced if the inflation rate () were _______ percent, given that all other factors relevant to supply remained the same? Aggregate Supply (AS) curve is upward sloping Equilibrium Goods and services (G&S) purchased AD C + I + G = = = Goods and services (G&S) produced AS GDP Question: Why is the aggregate supply (AS) curve upward sloping? Preview: The Aggregate Supply Curves Long Run Aggregate Supply (LRAS) Curve Vertical Placeholder for potential GDP (GDPP) (%) LRAS AS We will shortly explain precisely what we mean by potential GDP. Aggregate Supply (AS) Curve AS Question: How many final goods and services would be produced if the inflation rate () were _______ percent, given that all other factors relevant to supply remained the same? E GDPP Claims: The AS curve Is upward sloping. Intersects the LRAS curve at the expected inflation rate, E. G&S Expected Inflation Rate Question: Why is the expected inflation rate important? Answer: Wages are typically set for a specified time in the future. Workers base their wage demands Employers base the wage concessions they on the rate of inflation are willing to make on the rate of inflation they expect in the future. they expect in the future. Wage increases are based on the expected inflation rate. Affects Affect Expected wages in the firm costs in the inflation upcoming year upcoming year rate Simplifying Assumptions Firm Costs: Firms incur only labor costs Stable Start: For many, many years: GDP = 2,000 Annual Increase = 2.0% in Prices Actual Inflation = 2.0% Rate () Expected Inflation = 2.0% Rate (E) Annual Increase = 2.0% in Wages Increase in Firm Costs = 2.0% Potential GDP (GDPP): The value of GDP whenever the actual inflation rate () equals the expected inflation rate (E) Potential GDP (GDPP) = 2,000 Aggregate Supply Curves Atkins’ Apple Orchard Anything special about Mr. Atkins orchard? No. Anything special about No. apple production? MCCurrent MCPrevious MRCurrent PCurrent = 102 2.0% MRPrevious PPrevious = 100 Mr. Atkins’ apple production unchanged. 2.0% 50 SRAS Curve Questions: How many LRAS curve is a place (%) final goods and services would be mark for potential produced if the inflation rate were GDP (GDPP) _____ 2.0 % given that all other factors relevant to supply remained the same? Wages and hence E =2.0 firm costs increase by 2.0% Generalization: Whenever the actual inflation rate () equals the expected inflation rate (E), final goods and services produced equals potential GDP (GDPP) Q (bushels) LRAS GDPP = 2,000 G&S Aggregate Supply Curves Atkins’ Apple Orchard MCCurrent Anything special about Mr. Atkins orchard or apple production? No. MCPrevious PCurrent = 103 MRCurrent 3.0% MRPrevious PPrevious = 100 Mr. Atkins’ apple production increases. 2.0% 50 SRAS Curve Questions: How many LRAS curve is a place (%) final goods and services would be mark for potential produced if the inflation rate were GDP (GDPP) _____ 3.0 % given that all other factors 3.0 relevant to supply remained the same? Wages and hence E =2.0 firm costs increase by 2.0% Generalization: Whenever the actual inflation rate () is greater than the expected inflation rate (E), final goods and services produced is greater than potential GDP (GDPP) Q (bushels) LRAS G&S GDPP = 2,000 Aggregate Supply Curves Atkins’ Apple Orchard MCCurrent Anything special about Mr. Atkins orchard or apple production? No. PCurrent = 101 MCPrevious 1.0% MRCurrent MRPrevious 2.0% Mr. Atkins’ apple production decreases. PPrevious = 100 50 SRAS Curve Questions: How many LRAS curve is a place (%) final goods and services would be mark for potential produced if the inflation rate were P) GDP (GDP 1.0 % given that all other factors _____ 3.0 relevant to supply remained the same? Q (bushels) LRAS AS Wages and hence E =2.0 firm costs increase by 2.0% 1.0 Generalization: Whenever the actual inflation rate () is less than the expected inflation rate (E), final goods and services produced is less than potential GDP (GDPP) G&S GDPP = 2,000