Graphs

Production Possibilities Curve

• Displays concepts of economic efficiency and economic growth

• The curve represents all the possible combinations of capital and consumer goods that can be produced using the nation’s available factors of production

  • Capital

  • Land

  • Labor

• Interpretation:

  • Points on the line are EFFICIENT

  • Points below the line are INEFFICIENT

  • Points above the line are UNATTAINABLE (for now)

Curve will shift right when:

• Factors of production increase

• Technology increases

• Free trade is established

Supply & Demand (Micro)

• The graph that represents a Market

  • Law of Supply: Direct relationship between price and QS

  • Law of Demand: Inverse relationship between price and QD

  • Price change = Change of QS and QD ONLY

• If something other than the price changes, the curve will shift

  • Left = Decrease

  • Right = Increase

• Non Price Determinants of Supply

  • Producer expectations

  • Regulations

  • Other sellers

  • Various taxes

  • Input costs

  • Different (new) production technology

  • Environment

• Non Price Determinants of Demand

  • Buyer Expectations

  • Related Goods

  • Annual Income

  • Number of Buyers

  • Desires and Tastes

AS/AD Model

• LRAS = Long-Run Aggregate Supply

  • Period of time where resource prices are completely flexible

  • PL DOESN'T affect output in the long-run

• SRAS = Short-Run Aggregate Supply

  • Period of time where resource prices are sticky

  • PL DOES affect output in the short-run

• AD = Aggregate Demand

  • Inverse relationship with PL

  • 4 Components of GDP = AD Components

• Output Gap = (actual output –potential output)/potential output

  • Positive Gap = Inflation is a problem

  • Negative Gap = Unemployment is a problem

Investment Demand

• Shows the demand for gross private investment (I_g)

  • AKA “Business Investment”

• Business investment is extremely sensitive to the real interest rate

  • Inverse relationship between interest rates and investment is illustrated by the downward slope of the investment demand curve

• Use this graph to explain the effects of government borrowing on economic growth vis a vis “crowding out”

Loanable Funds Model

• Shows the supply and demand of money to be loaned in a country’s banking system

• Supply of Loanable Funds

  • Equal to all the savings in domestic banks

  • SLF increases if savings increases

  • SLF decreases if savings decrease

• Demand for Loanable Funds

  • Equal to all the public and private sector demand for loans

    • ex. Businesses, households, and government borrowing

    • If borrowing increases, DLF increases

    • If borrowing decreases, DLF decreases

Money Market (Limited Reserves)

• Shows the impact of monetary policy actions by the Fed in a limited reserve system

  • Limited Reserves = Banks hold no excess reserves or very few excess reserves

• Money Supply (MS)

  • Under the control of the Fed

  • M1 supply of money (highly liquid)

  • Perfectly inelastic because the nominal interest rate doesn’t impact the quantity of money in circulation

  • Shifts due to open market operations

    • Buy = Big

    • Sell = Small

• Money Demand (MD)

  • Demand for liquid money (cash & demand deposits)

  • Nominal interest rate increases the opportunity cost of holding cash

  • Shifts due to changes in-

    • Real GDP

    • Price Level

    • Banking technology

    • Government banking regulations

Reserve Market Graph (Ample Reserves)

• Shows supply and demand for bank reserves (excess reserves) at the Fed

  • S_R is the supply of the reserves and D_R is the demand for reserves by financial institutions (banks)

• Policy Rate = The Fed Funds Rate; determined by the intersection of S and D and is the price of reserves in the market.

• Administered Interest Rates = Interest rates that the Fed controls directly; the Discount Rate and IOR are the only two you need to know

  • Discount Rate = Top dashed line

  • Interest on Reserves (IOR) = Bottom dashed line

    • Banks won’t demand reserves at any rate higher than the Discount Rate

    • Banks won’t lend to e/o at any rate lower than the Interest on Reserves

  • Downward sloping section of the demand line is the “limited reserves” portion of the graph

• OMOS don’t change the money supply in Ample Reserves

• On this graph:

  • Lowering Administered Rates = Expansionary

  • Raising Administered Rates = Contractionary

Phillips Curve

• Shows the relationship between unemployment and inflation in both the short and long-run.

  • SRPC = Ue% and π% ARE inversely related.  Each SRPC intersects the LRPC at the expected inflation rate

  • LRPC = Ue% and π% ARE NOT related

• Shifts of AD cause MOVEMENT along the SRPC

  • Mirror image of AS/AD graph points

• Shifts of SRAS cause SHIFTS of the SRPC

  • Mirror image of the AS/AD graph points

• Changing expectations of inflation cause shifts of the SRPC

Exchange Rates

• Shows how the value of currency on the Foreign Exchange Market changes due to capital inflows and outflows

• Determinants

  • Interest rates

  • Inflation rates

  • Economic growth

  • Purchasing Power Parity

  • Popularity of imports

• You must first determine which currency is in demand, then…

  • Shift the demand for the appropriate currency

  • Shift supply of the other currency

  • Both shift in the SAME DIRECTION

  • One will always appreciate, the other will always depreciate

Formulas

• GDP = C+ I + G + X

  • C = Consumer spending

  • I_g = Gross Private Investment (Business Investment)

  • G = Government spending

  • X_n = Net Exports (Imports - Exports)

• Price Index = (Nominal Value/Real Value)*100

  • CPI and GDP Deflator and the two indices you need to know

• Real Income = Nominal Income/Price Index

  • Use this to calculate “Real GDP” or “Real Household Income” with the GDP deflator or CPI, respectively, as the price index in the denominator

• Rate of Change = (x₂-x₁/x₁)*100

  • x₁ = original value or starting calue of x

  • x₂ = new value or ending value of x

  • use this formula to calculate the rate of inflation, economic growth, or the size of an output gap on the AS/AD model

• Unemployment Rate = (Unemployed/Labor Force)*100

• Labor Force = Employed + Unemployed

• Labor Force Participation = (Labor Force/Adult Population)*100

• Real Interest Rate = Nominal Interest Rate - Expected Inflation Rate

• Nominal Interest Rate = Real Interest Rate + Expected Inflation Rate

• Marginal Propensity to Consume (MPC) = Change in Spending/Change in Disposable Income

• Marginal Propensity to Save (MPS) = Change in Savings/Change in Disposable Income)

  • If you are given the MPC, you can find the MPS with this formula:

    • MPS = 1-MPC

    • If you are given the MPS, you can find the MPC the same way

• Spending Multiplier = 1/MPS

  • Most often used to calculate the impact of government spending (fiscal policy) on GDP (national income)

• Tax Multiplier = MPC/MPS

  • Used to calculate the impact of tax cuts or increases (fiscal policy) on GDP (national income)

  • Remember: Tax Multiplier will ALWAYS be one less than the Spending Multiplier

• Money Multiplier = 1/Reserve Requirement Ratio

  • Used to calculate the impact of open market operations (Monetary Policy) or new bank deposits on the M1 money supply in a limited reserves system

• Velocity of Money = (Price Level*Real Output)/Money Supply

  • Price Level = CPI

  • Real Output = Real GDP

  • Money Supply = M1

  • Tells you how many times a dollar is used to purchase goods in a given period of time

• Quantity of Money Equation: M*V = Y*P

  • M = M1 Money Supply

  • V = Velocity of Money

  • Y = Real Output AKA Real GDP

  • P = Aggregate Price Level AKA CPI

  • Used to demonstrate that changes in the money supply or velocity of money will cause proportional changes to real GDP and the price level (inflation)

• Present Value = Amount to be received in period N/(1+r)^N

  • N = Number of times (periods) compounded

  • r = interest rate

  • Tells you the exact amount of money you would need to invest today at the current interest rate (r) to receive the exact same amount of money promised to you in period N

• Future Value = X(1+r)^N

  • X = Principal Investment

  • r = Interest Rate

  • N = Number of times (periods) compounded

  • Used to calculate how much a given sum of money (X) will yield if invested for N periods at the current interest rate ®