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Aggregate Supply and Aggregate Demand Model

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Enables us to analyze changes in real GDP and the price level simultaneously

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Aggregate Demand

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A schedule or curve that shows the amounts of real output (real gdp) that buyers collectively desire to purchase at each possible price level

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Substitution Effect

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As price falls the consumer wants to buy more of the product because it becomes relatively less expensive than other goods

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Real balances effect

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This is a result of a change in the price level. A higher price level reduces the real value or purchasing power of the public's accumulated savings balances. The value of assets with fixed money values (savings accounts or bonds) diminishes. A higher price level erodes the purchasing power of such assets and the public is poorer and will reduce the spending.

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Interest rate effect

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The aggregate demand curve slopes downward because of this. The tendency for increases in the price level to increase the demand for money, raise interest rates, and, as a result, reduce total spending and real output in the economy (and the revers for price level decreases)

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Foreign Purchases Effect

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Another reason why the aggregate demand curve slopes downward. The inverse relationship between the net exports of an economy and its price level relative to foreign price levels

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Determinants of aggregate demand (aggregate demand shifters)

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Factors such as consumption spending, investment, government spending, and net exports that, if they change, shift the aggregate demand curve

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Consumer wealth

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The total dollar value of all assets owned by consumers in the economy less the dollar value of their liabilities (debts)

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Wealth Effect

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An unforseen increase in the stock market is a good example: The increase in wealth prompts pleasantly surprised consumers to save less and buy more out of their current incomes than they had previously been planning.

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Reverse Wealth Effect

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An unexpected decline in asset values will cause an unanticipated reduction in consumer wealth at each price level, consumers tighten their belts and increase savings and reduce consumption, shifting aggregate demand curve to left.

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Investment spending

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The purchase of capital goods. The second major determinant of aggregate demand

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Government Spending

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Government purchases are the third determinant of aggregate demand. An increase in government purchases will shift aggregate demand curve to right.

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Aggregate supply

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A schedule or curve showing the relationship between the price level and the amount of real domestic output that firms in the economy produce. Varies depending on the time horizon and how quickly output prices and input prices can change.

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Immediate short run aggregate supply curve

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An aggregate supply curve for which real output, but not the price level, changes when the aggregate demand curve shifts; a horizontal aggregate supply curve that implies an inflexible price level

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Short run Aggregate Supply Curve

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An aggregate supply curve relevant to a time period in which input prices (particularly nominal wages) do not change in response to changes in the price level

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Per Unit Production cost

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Total input cost divided by units of output

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Long run aggregate supply curve

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The aggregate supply curve associated with a time period in which input prices (especially nominal wages) are fully responsive to changes in the price level

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Determinants of aggregate supply

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Factors such as input prices, productivity, and the legal institutional environment that, if they change, shift the aggregate supply curve.

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Productivity

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Total output over total inputs

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Equilibrium Price Level

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The price level at which the aggregate demand curve intersects the aggregate supply curve

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Equilibrium real output

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The gross domestic product at which the total quantity of final goods and services purchased (aggregate expenditures) is equal to the total quantity of final goods and services produced (the real domestic output); the real domestic output at which the aggregate demand curve intersects the aggregate supply curve

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Demand Pull Inflation

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Increases in the price level (inflation) resulting from an excess of demand over output at the existing price level...caused by an increase in aggregate demand.

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Cost Push Inflation

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Increases in the price level (inflation) resulting from an increase in resource costs (for example raw material prices) and hence in per unit production costs; inflation caused by reductions in aggregate supply

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Fiscal Policy

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changes in government spending and tax collections designed to achieve a full employment and noninflationary domestic output

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Counsel of Economic Advisors

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A group of three persons that advises and assists the president of the United States on Economic matters (including the preparation of the annual economic report of the president.

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Expansionary Fiscal Policy

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An increase in government purchases of goods and services, a decrease in net taxes, or some combination of the two for the purpose of increasing aggregate demand and expanding real output

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Budget Deficit

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the amount by which the expenditures of the federal government exceed its revenues in any year

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Budget Surplus

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The amount by which the revenues of the federal government exceed its expenditures in any year

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Progressive Tax System

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A tax whose average tax rate remains constant as the taxpayers income increases or decreases

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Proportional tax system

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A tax whose average tax rate remains constant as the taxpayer's income increases or decreases

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Regressive tax system

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A tax whose average tax rate decreases as the tax payers income increases and increases as the taxpayers income decreases

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standardized budget

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A comparison of the government expenditures and tax collections that would occur if the economy operated at full employment throughout the year; the full employment budget

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Political business cycles

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The alleged tendency of congress to destabilize the economy by reducing taxes and increasing government expenditures before elections and to raise taxes and lower expenditures after the election

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U.S. Securities

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US treasury bills, notes and bonds used to finance budget deficits; the components of the public debt

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External Public Debt

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The portion of the public debt owed to foreign citizens, firms, and institutions.

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Built in stabilizer

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A mechanism that increases government's budget deficit (or reduces its surplus) during a recession and increases an expansion without any action by policymakers. The tax system is one such mechanism

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cyclical deficit

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A federal budget deficit that is caused by a recession and the consequent decline in tax revenues

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crowding out effect

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A rise in interest rates and a resulting decrease in planned investment caused by the Federal government's increased borrowing to finance budget deficits and refinance debt.

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public debt

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The total amount owed by the federal government to the owners of government securities; equal to the sum of past government budget deficits less government budget surpluses

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public investments

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Government expenditures on public capital such as roads, highways, bridges, mass transit systems, and electric power facilities, and on human capital such as education training and health

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Medium of exchange

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Any item sellers generally accept and buyers generally use to pay for a good or service; money; a convenient means of exchanging goods and services without engaging in barter

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Units of account

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A standard unit in which prices can be stated and the value of goods and services can be compared; one of three functions of money

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store of value

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An asset set aside for future use; one of the three functions of money

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liquidity

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The ease with which an asset can be converted quickly into ash with little or no loss of purchasing power. Money is said to be perfectly liquid, whereas other assets have a lesser degree of liquidity

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M1

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The most narrowly defined money supply, equal to currency in the hands of the public and the checkable deposits of commercial banks and thrift institutions

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Federal Reserve Notes

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Paper money issued by the federal reserve banks

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Token money

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Bills or coins for which the amount printed on the currency bears no relationship to the value of the paper or metal embodied within it; for currency circulating, money for which the face value exceed the commodity value.

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Checkable deposits

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Any deposit in a commercial bank or thrift institution against which a check may be written

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Commercial banks

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A firm that engages in the business of banking (accepts deposits, offers checking accounts, and make loans)

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Thrift Institutions

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A savings and loan association, mutual savings bank, or credit union

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Near monies

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Financial assets, the most important of which are non checkable savings accounts, time deposits, and US short term securities and savings bonds, which are not a medium of exchange but can readily be converted into money

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M2

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A more broadly defined money supply, equal to M1 plus non checkable savings accounts (including money market deposit accounts), small time deposits (deposits of less than 100,000) and individual money market mutual fund balances.

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Savings account

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A deposit in a commercial bank or thrift institution on which interest payments are received; generally used for saving rather than daily transactions; a component of the M2 money supply

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Money Market deposit account

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Bank and thrift provided interest bearing accounts that contain a variety of short term securities; such accounts have minimum balance requirements and limits on the frequency of withdrawals

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Time deposits

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An interest earning deposit in a commercial bank or thrift institution that the depositor can withdraw without penalty after the end of a specific time period

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Money market mutual fund

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Interest-bearing accounts offered by investment companies, which pool depositors funds for the purchase of short term securities. Depositors can write checks in minimum amounts or more against their accounts

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legal tender

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A legal designation of a nation's official currency (bills and coins). Payment of debts must be accepted in this monetary unit, but creditors can specify the form of payment, for example, cash only or check or credit card only

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Federal reserve system

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The US central bank, consisting of the Board of Governors of the Federal Reserve and the 12 Federal Reserve banks which controls the lending activity of the nations banks and thrifts and thus the money supply; commonly referred to as the fed

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Board of governors

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The seven member group that supervises and controls the money and banking system of the United States; the board of governors of the federal reserve system; the federal reserve board.

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Federal Reserve Banks

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The 12 banks chartered by the US government to control the money supply and perform other functions

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Federal open market committee

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The 12 member group that determines the purchase and sale policies of the Federal Reserve Banks in the market for US government securities.

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financial services industry

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The broad category of firms that provide financial products and services to help households and businesses earn interest, received dividends, obtain capital gains, insure against losses, and plan for retirement. Includes commercial banks, thrifts, insurance companies, mutual fund companies, pension funds, investment banks, and security firms.

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electronic payments

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Purchases made by transferring funds electronically. Examples: fedwire transfers, automated clearing house transactions (ACH's) payments via the PayPal system, and payments through stored value cards

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Fractional reserve banking system

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A reserve requirement that is less than 100 percent of the checkable deposit liabilities of a commercial bank or thrift institution.

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balance sheet

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A statement of the assets liabilities, and net worth of a firm or individual at some given time.

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vault cash

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The currency a bank has in its vault and cash drawers

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required reserves

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The funds that banks and thrifts must deposit with the federal reserve bank or hold as vault cash to meet the legal reserve requirement; a fixed percentage of the bank's or thrifts checkable deposits

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reserve ratio

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The fraction of checkable deposits that a bank must hold as reserves in a federal reserve bank or in its own bank vault; also called the reserve requirement

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excess reserves

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The amount by which a bank's or thrift's actual reserves exceed its required reserves; actual reserves minus required reserves

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actual reserves

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the funds that a bank has on deposit at the federal reserve bank of its distrcit

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federal funds rate

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The interest rate banks and other depository institutions charge one another an overnight loans made out of their excess reserves

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monetary multiplier

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The multiple of its excess reserves by which the banking system can expand checkable deposits and thus the money supply by making new loans (or buying securities); equal to 1 divided by the reserve ratio

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monetary policy

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A central banks changing of the money supply to influence interest rates and assist the economy in achieving price stability, full employment and economic growth.

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interest

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the payment made for the use of money (of borrowed funds)

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transactions demand

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The amount of money people want to hold for use as a medium of exchange (to make payments); varies directly with nominal GDP

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asset demand

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the amount of money people want to hold as a store of value; this amount varies inversely with the interest rate

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total demand for money

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The sum of the transactions demand for money and the asset demand for money

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open market operations

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The buying and selling of US government securities by the federal reserve banks for purposes of carrying out monetary policy

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discount rate

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the interest rate that the federal reserve banks charge on the loans they make to commercial banks and thrift institutions

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term auction facility

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The monetary policy procedure used by the Federal Reserve, in which commercial banks anonymously bid to obtain loans being made available by the Fed as a way to expand reserves of the banking system.

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federal funds rate

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The interest rate banks and other depository institutions charge one another on an overnight loans made out of their excess reserves

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expansionary monetary policy

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Federal reserve system actions to increase the money supply lower interest rates and expand real GDP; an easy money policy

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prime interest rate

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the bench mark interest rate that banks use as a reference point for a wide range of loans to businesses and individuals

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restrictive monetary policy

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Federal reserve system actions to reduce the money supply, increase interest rates, and reduce inflation; a tight money policy

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Taylor Rule

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A modern monetary rule proposed by economist John Taylor that would stipulate exactly how much the Federal Reserve should change real interest rates in response to divergences of real GDP from potential GDP and divergences of actual rates of inflation from a target rate of inflation

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cyclical asymmetry

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The idea that monetary policy may be more successful in slowing expansions and controlling inflation than in extracting the economy from a sever recession

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mortgage debt criss

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The period beginning in late 2007 when thousands of homeowners defaulted on mortgage loans when they experienced a combination of higher mortgage interest rates and falling home prices.

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