Loanable funds market

Demanders/Suppliers

Demander: borrowers

Suppliers: Creditors

Banks

Use available savings to make loans

Domestic savings

How much people save

Changes with interest rate (high interests rates means people save more, while low interest rates discourage saving.)

Saving can be negative

Capital inflow

Foreign lenders lend money to the USA

Japan invests in the USA.

Capital outflow

USA lends money to foreign borrowers. 

If Yen appreciates and the dollar depreciates,

US goods are cheaper for Japanese citizens, meaning that they will be bought more.

The aggregate expenditure model ( AE model)

Assumptions

• Their is a fixed price (if spending goes up, price stays)

• Consumption can be broken into two parts (fixed and autonomous consumption)

• No depreciation and no indirect business taxes

• All we have is GDP and disposable income

If equilibrium less than potential GDP

Recessionary Gap

Output and spending are too low

Must increase government spending or lower taxes

If equilibrium is greater than potential GDP

Inflationary Gap
Output and spending are too high
Need to decrease government spending or increase taxes