TEST REVIEW MACRO UNIT-3

Unit #3 Key Graphs AS/AD Model PPF

AS/AD Short Run Equilibrium Output deviates only in short run when actual price level deviates from expected price level In long run, wages & prices are not “sticky” and do not affect output (price level has no effect) Prices/wages become flexible!

Why the AD curve is Downward Sloping The Wealth Effect The Interest Rate Effect Exchange Rate Effect Y = C + I + G + NX

Shifts in AD Curve Shifts arise from changes in any of the 4 Determinants of AD Consumption Investment Government Purchases Net Exports AD = C + I + G + NX

Shifts in SRAS & LRAS Curve If PPF shifts => LRAS shifts. Expected Price Level Input Prices Labor Capital Natural resources Technology Gov’t Incentives Shift ONLY SRAS => NOT LRAS Changes in the other 5 variables Shifts BOTH curves (LRAS & SRAS & PPF)

Contractionary Fiscal Policy Inflationary Gap 2 Ways to get back to full potential Contractionary Fiscal Policy Gov’t would raise income taxes => (C↓) Decrease Gov’t Spending (G↓ ) End result: AD shifts left, deficit falls Classical Economics At E1 actual price level is HIGHER than expected price level Expected price level rises, => SRAS decreases End result: SRAS shifts left

Expansionary Fiscal Policy Recessionary Gap Economy below full output Expansionary Fiscal Policy Gov’t would lower income taxes => (C↑) Increase Gov’t Spending (G↑) End result: AD shifts right, debt rises

Savers & Investors Loanable Funds is where savers & investors meet Savers buy securities (bonds) Investors borrow money Savers = Supply curve of loanable funds Private savings = Firms & households savings Public savings = government savings (it can be negative!) National Savings = Public & Private savings Investors = Demand curve for loanable funds Business demands loans for investment (I in GDP)

Government Budget Deficit Real Interest S2 S1 Rate D 1. A budget deficit Decreases supply of Loanable funds National Savings ↓ $800 6% 2. . . . This raises Real interest rate Business Investment crowed out! $1,200 5% Loanable Funds 3. . . . and reduces the equilibrium quantity of loanable funds. (in billions of dollars)

Government Spending Social Security 22.0% Medicare 14.0% Medicaid 7.0% Interest on Debt 6.0% Defense Spending 18.0% Homeland Security 1.0% Education 2.0% Other 26.0 Total 100.0% 43% of Budget 24% of Budget THANK YOU!

Not Enough Workers? The ratio of workers to retirees is falling This means less money coming in => more going out