Midterm #2

• The aggregate supply curve describes for each given level, the quantity of output firms are willing to supply
• The aggregate demand curve shows the combinations of the price level and level of output at which the goods and money markets are simultaneously in equilibrium.
• An increase in the nominal money stock shifts AD to the right.
• The horizontal Keynesian AS curve implies that any amount of input will be supplied at the existing price level.
• The vertical classical supply function is based on the assumption that there is always full employment so output is at y*.
• Output at the full employment of the labor force is potential GDP.
• Potential GDP is exogenous with respect to the price level.
• Due to unemployment, firms can obtain as much labor as they want at the current wage.
• Short run stickiness


  In the short run, firms are reluctant to change prices when demand shifts. (The price level does not depend on GDP)
• The natural rate of unemployment is the rate rising from normal labor market frictions when the market is in equilibrium
• If output is obtained above the full employment level above Y*, prices will continue to rise over time.
• Expansionary policies moves AD to the right
• Aggregate demand depends on the real money supply.
• Real money supply


  value of the money provided by the central bank and the banking system
• Real money supply equals nominal money stock divided by price level
• When real money supply rises, interest rates fall and investment rises, leading overall aggregate demand to rise
• When the real money supply falls, it lowers investment and AD.
• High prices means a low money supply.
• M times V = P times Y (nominal GDP)
• If velocity is constant, then the equation is an aggregate demand curve
• With the money supply constant, any increase in Y must be offset by a decrease in P
• The inverse relation between output and price gives the downward slope of AD.
• An increase in the nominal money stock shifts the AD schedule up exactly in proportion to the increase in nominal money.
• In the Keynesian case, given a perfectly elastic supply, shifting AD to the right will increase output but leave the equilibrium price level unchanged.
• Supply side policies moves the aggregate supply curve to the right by increasing potential GDP
• Supply-side policies are usually used to reference the idea that cutting tax rates will increase aggregate supply so that tax collections will rise.
• Only supply-side policies can permanently alter output.
• Prices rise whenever aggregate demand moves out more than aggregate supply.
• A recession occurs when real GDP falls below potential GDP.
• If an economy has too much inflation, it may be because its aggregate demand exceeds its aggregate supply.
• The economy is at full employment when there is no excess capacity or unemployment.
• Monetary and fiscal policy can be used to alter the economy
• Short term tuning is done with monetary policy
• The Fed sets the interest rate of the economy through the federal funds rate
• Taylor Rule


  a guideline for setting the target for the federal funds rate
• Federal funds


  the short term interest rate banks pay to borrow reserves from one another
• Lower interest rates encourage greater investment spending and greater consumption, increasing aggregate demand
• Monetary policy works through moving aggregate demand
• Central banks choose short-run policy with 2 goals

  1. Keep economic activity high
  2. Keep inflation low
• Central bank policies shift the AD curve along the AS curve, changing priices but not output