Principles of Macroeconomics Review

Flashcards covering key vocabulary and concepts from Chapters 12-14.

Contractionary (Tight) Monetary Policy

When the Fed contracts the money supply, which increases the interest rate.

Tight Monetary Policy Actions

The Federal Reserve can do tight policy by increasing the required reserve ratio (g), increasing the discount rate, increasing the Federal Funds Rate (key interest rate), selling bonds on the open market.

Expansionary (Easy) Monetary Policy

When the Fed expands the money supply, which decreases the interest rate.

Easy Monetary Policy Actions

The Federal Reserve can do easy policy by decreasing the required reserve ratio (g), decreasing the discount rate, decreasing the Federal Funds Rate (key interest rate), buying bonds on the open market.

Link 1: Income and the Demand for Money

As income (Y) goes up, we hold more money (Md) and vice-versa.

Link 2: Planned Investment Spending and Interest Rate

As interest rates go up, planned investment (I) goes down, and vice-versa.

Crowding-Out Effect

When the government increases spending (expansionary fiscal policy) – the increase in govt spending leads to an increase in income, which means there’s an increase in Md, and this cause interest rates to go up– which makes some level of investment drop.

Aggregate Demand Curve (AD)

Negative relationship between aggregate output (Y) and price level. Aggregate demand falls when price level increases.

The Consumption Link

Decrease in consumption when increase in interest rates, causes the AD curve to slope downward

AD Curve Equilibrium

Each point on the AD curve is a point at which both the goods market and money market are in equilibrium

The Real Wealth Effect

When price levels rise, they cause our wealth (accumulated saving) to fall. When price levels go up, our purchasing power goes down.

Shifts of Aggregate Demand Curve

Increase in money supply or increase in govt spending, causes the curve to shift to the right.

Aggregate Supply Curve (AS)

Graph that shows the relationship between aggregate quantity of output supplied and overall price level; also called the “price/output response curve”

Short Run AS Curve

Input prices – specifically wage rates, tend to lag behind

Long Run AS Curve

Vertical

Cost Shock

Shift the AS curve to the left. Example: Bad weather is a cost shock that shifts to the left – AS curve shifts left and output falls, but price level shoots up.

Short Run and Long Run AS Curves and Policy Effects

In the short run, monetary and/or fiscal policy can have an effect on the economy. However, in the long run, when the AS curve is vertical, no policy has an effect (so any expansionary policy will cause inflation to occur)

Classical AS Curve

Always vertical – because the economy will correct itself in this model…so any expansionary policy (govt intervention) will cause inflation.

Unemployment and the Classical View

Unemployment rate is not necessarily an indicator of whether the labor market is working properly

The Classical Labor Market and the Aggregate Supply Curve

Wages respond quickly to price changes. In Classical view, AS curve is vertical

Short Run Relationship Between Unemployment and Inflation

As (Y) increases, unemployment decreases. When Y increases, price level increases.

The Philips Curve

Inflation Rate vs. Unemployment Rate