Macro Final Topic Review Savings & Leakage Economic Schools of Thought

DEMAND FOR MONEY Money Market MS MD You usually do not have to shift MD The Fed. Controls MS and that moves with monetary policy HOWEVER- sometimes they shift MD on the exam For example: 1) If the stock market crashes—people hold more Money (precautionary demand) and MD shifts right 2) If the price level ↑, then MD shifts right Money Market Nominal Interest Rate MS Demand for Money: Transactions Demand Precautionary Demand Speculative Demand MD Qty $ Price Level changes shifts Demand Curve for Money ↑ Px level shifts MD right ↓Px level shifts MD left

Injections & Leakages Injections - income of firms which does not normally arise from the expenditure of households changes in investment, government spending or exports. Leakages - Income not passed on by consumers in the circular flow savings, taxation or imports

GDP Leakage GDP = Y = C + I + G + (X – M) Leakage to GDP: S + T + M (S = Savings T= taxes M = Imports) Injections to GDP: I + G + X (Investment, Gov’t, Exports) In equilibrium: Leakage = Injections S + T + M = I + G + X Savings must end up as Investment

Leakage Injections

Tariffs & Quotas Revenue Tariff - designed to raise revenue Protective Tariff – designed to protect domestic market Quotas- limit # of goods imported Price S World Price: when above domestic price we export P ------------- World Price: when below domestic price we import ------------ D US Market (Wheat)

Tariffs & Quotas: will always produce deadweight loss and lower consumer surplus lead to higher prices & protect inefficient producers Price Sdomestic STariff SWorld P ------------- ------------ D World Qty (Wheat

Phillips Curve Short & Long Run (b) The Phillips Curve The Phillips Curve Inflation Rate Inflation Long-run Phillips (percent Phillips curve Rate curve per year) 3. . . . and increases the inflation rate . . . (output is 8,000) B 4 6 B (output is 7,500) A 7 2 A Unemployment Rate (percent) Natural rate of Unemployment unemployment Rate You may have to draw a Phillips Curve Remember—Unemployment on x-axis

If real interest rates rise in the USA, then the dollar appreciates a) Europeans supply Euros and demand dollars If the price level rises in the USA, then the dollar depreciates a) European goods look “cheap” => supply dollars demand Euros

Economic Schools of Thought Classical View Markets are naturally self regulating (No Gov’t intervention) Recessions are temporary, Wages & Prices are flexible Keynesian View Economy is inherently unstable, Not self regulating Wages & prices are sticky (Gov’t intervention needed) Monetarist View Money matters!----do not regulate economy—control inflation Supply Side View Incentives matter! Create incentives to increase LRAS