Production Possibilities Frontier Supply and Demand Currency Market AD-AS Model Loanable Funds Model Phillips Curve Money Market

1 Production Possibilities Graph Assumptions: Movements Full Employment Fixed Resources and Technology Movements Along curve shows opportunity cost Outward shift illustrates economic growth Inward shift indicates destruction of resources Producing Capital Goods will lead to greater economic growth than producing consumer goods. (Butter will lead to more growth than guns)

Production Possibilities Graph Capital Goods Points A,B,C, are efficient pts. Point D is underutilization Point E is economic growth A E May Lead to most Future growth May Lead to most Future economic growth B D C Consumer Goods

2 Supply and Demand

Demand Changes when: Income changes Related Products, complements and substitutes, (price or quality change) Expectations (future price change) Consumers (more or less added) Tastes, Fads, Preferences change

Demand Increase: As Demand Increases, Price and Quantity Increase as well.

Demand Decrease: As Demand Decreases, Price and Quantity decrease as well

Supply Changes When: Input prices change (resources and wages) Government (tariffs, quotas, and subsidies) Number of sellers change Expectations (about price and product profitability change) Disasters (weather, strikes, etc..)

Supply Increase: As Supply Increases, Quantity Increases, but Price Falls. D1 Quantity Q1 Q2

Supply Decrease: As Supply Decreases, Quantity Decreases, but Price Increases.

Price Floor D S P P Surplus Qd Price set above equilibrium Producers produce too much Consumers demand less than what is produced Surplus created – Qs > Qd D S P P Surplus Qd

Price Ceiling D S P P Shortage Qs Qd Qd Price set below equilibrium Consumers demand too much Producers produce too little Shortage created – Qd > Qs D S P P Shortage Qs Qd Qd

3 Currency Market

Currency Terms Appreciation: Currency is increasing in demand (stronger dollar) U.S. Currency will appreciate when more foreigners: travel to the U.S., buy more U.S. goods or services, or buy the U.S. dollar to invest in bonds

Currency Terms Depreciation: Currency is decreasing in demand (weaker dollar) Being SUPPLIED in exchange for other currency. U.S. Currency will depreciate when fewer foreigners: travel to the U.S., buy fewer U.S. goods or services, or sell the U.S. dollar to invest in their own bonds

4 AD-AS Model

Aggregate Demand Downward sloping: Real-Balances Effect: change in purchasing power 2. Interest-Rate Effect: Higher interest rates curtail spending Foreign Purchase Effect: Substitute foreign products for U.S. products Price Level AD (C + I + G + X) Real GDP

Aggregate Demand Determinants of AD: C + I + G + Nx An increase in any of these will increase AD and shift the curve to the right. A decrease in any of these will cause a decrease in AD and shift the curve to the left

Aggregate Demand Determinants Consumption Wealth Expectations Debt Taxes Investment Interest Rates Expected Returns Technology Inventories Government Change in Gov. spending Net Exports National Income Abroad Exchange Rates

Aggregate Supply Factors: R: resource prices (wages and materials, as well as OIL) A: actions by government (Taxes, Subsidies, more regulation) P: productivity (better technology)

Aggregate Supply Short Run: Long Run: Assumes that nominal wages are “sticky” and do not respond to price level changes. Is Upward sloping as businesses will increase output to maximize profits Long Run: Curve is vertical because the economy is at its full-employment output. As prices go up, wages have adjusted so there is no incentive to increase production.

Real GDP or Real output or Real income

Recessionary Gap

Inflationary Gap

5 Loanable Funds

Loanable Funds Market Demand for Loanable Funds Loanable funds are used for three purposes Business Investment Government deficit financing International Investment or lending

Demand for Loanable Funds Curve The demand for loanable funds shows the relationship between the real interest rate and the quantity of loanable funds demanded.  It shows that the quantity of loanable funds will be lower at a high real interest rate than at a lower real interest rate.

Loanable Funds Market Supply of Loanable Funds Loanable funds come from three places Private savings Governmental budget surpluses International borrowing

Supply of Loanable Funds Curve i 6% 4% 40 60 LF

Equilibrium in the Loanable Funds Market

Shifts in Demand for Loanable Funds The major determinant of the demand for loanable funds is expected profit.  When the expected profit changes, the demand for loanable funds changes.  The greater the expected profit of new capital, the greater is the amount of investment and the greater is the demand for loanable funds.  When the expected profit increases and we earn more from our investment, the more affordable it becomes to borrow loanable funds – even when the interest rate.

Shifts in Supply of Loanable Funds Disposable income (shifts the supply of loanable funds) Wealth (shifts the supply of loanable funds) Expected future income (shifts the supply of loanable funds) Default risk (shifts the supply of loanable funds)

6 Phillips Curve

7 Money Market