45o P E E (r2) E (r1) AD Y Y RLMS1 r RLMS2 r IRE RLMD M/P IRE E2 P1 E1

E (r3) E 45o P E (r2) E (r1) AD1 AD2 Y Y RLMS1 r RLMS2 RLMS3 r IRE RLMD r3 r3 M1/P1 M1/P2 M2/P2 M/P IRE1 IRE2 IRE3 IRE

(1) Monetary policy P Expansionary monetary policy => AD0 -> AD1 Contractionary monetary policy => AD0 -> AD2 AD2 AD0 AD1 Y

E (r2) E 45o P E (r2) E (r1) AD1 AD2 Y Y RLMS1 r RLMS2 r IRE RLMD M/P

(2) Fiscal policy P Expansionary fiscal policy G TP, TB => C, I => AD0 -> AD1 Contractionary fiscal policy G TP, TB => C, I AD2 AD0 AD1 => AD0 -> AD2 Y

(3) Other factors AD: Y = f(P, TP, CC, W, CR, D, TB, PR, CU, G, Y*, R, MS) (-) (-) (+) (+) (+) (-) (-) (+) (+) (+) (+) (-) (+)

i) Crowding out r RLMS0 RLMS1 r RLMD1 IRE RLMD0 M/P IRE r1 r1 r0 r0 r2

r Yield curve Inverted yield curve Maturity

2. Aggregate supply curve Shows the price level at which firms are willing to produce different amounts of real goods and services Depends on the quantity and quality of resources used in production, the efficiency with which resources are used, and production technology

a. Short-run aggregate supply Amount of resources, efficiency of their use, and level of technology constant in short-run P SAS Classical region SR AS: P = f (Yf , resource costs) (0) (+) Intermediate region Y Keynesian region

b. Long-run aggregate supply Potential output – full-employment level of output Maximum amount that can be produced, given resources and technology available P SAS LAS Y Yf

c. Equilibrium P SAS LAS P* AD Y Y* Yf

a. Aggregate demand P SAS LAS AD0 -> AD1 => P Y => unemployment decreases but inflation increases AD1 AD0 Use contractionary monetary and / or fiscal policy to deal with the problem of inflation AD2 P1 AD0 -> AD2 => P Y => unemployment increases but inflation decreases P0 P2 Use expansionary monetary and / or fiscal policy to deal with the problem of unemployment Y Y2 Y0 Y1 Yf

b. Short-run aggregate supply SAS1 P SAS0 LAS Resource costs increase: SAS0 -> SAS1 => P Y unemployment increases and inflation increases Stagflation - worst possible situation: P1 - Using expansionary policy to deal with unemployment makes inflation worse P0 AD - Using contractionary policy to deal with inflation makes unemployment worse Y Y1 Y0 Yf

c. Long-run aggregate supply SAS LAS0 SAS LAS1 More resources, more efficient use of resources, improved technology => economic growth LAS0 -> LAS1 => P Y P0 => unemployment decreases and inflation decreases P1 AD Y Y0 (Yf)0 Y1 (Yf)1

5. Business cycle Y Time Peak Recession Expansion Turning points Trough Time