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1 Please read the following License Agreement before proceeding.
License Agreement for Use of Electronic Resources The illustrations and photographs in this PowerPoint are protected by copyright. Permission to use these materials is strictly limited to educational purposes associated with the course for which you have adopted Krugman’s Economics for AP®, Second Edition. You may project these materials in lectures, post them on password-protected course websites, include them in course documents, or use them in any other manner that is consistent with their intended use as materials to aid in the teaching of the course for which you have purchased Krugman’s Economics for AP®, Second Edition. The following restrictions apply to materials posted on course websites: The website must be available only to students taking the course for which you have adopted our program or to registered users of your institution’s network. They may not be posted on sites accessible to the general public outside your institution. Please note that this restriction is an IMPORTANT PROTECTION FOR YOU: Copyright holders will seek (and have sought) legal action if you post copyrighted photographs or other materials to open-access sites. If requested, you must provide BFW/Worth Publishers with the URL and password required to access the site. The name of the copyright holder (BFW/Worth Publishers, unless otherwise indicated) must appear with each item at all times. Note: Most of the photos herein are owned by other parties/individuals. The copyright holder is listed with the image. You may not post materials other than in the context of course material for the course for which you have adopted our program. You may not distribute these materials to others not associated with the course for which you have adopted our program. Nor may you use any of the materials in any context other than the teaching of this course, without first receiving written permission from the copyright holder (BFW/Worth Publishers, unless otherwise indicated). In using these PowerPoint slides, you agree to accept responsibility for protecting the copyrights to the materials contained herein. If you have any questions regarding permitted uses of these materials, please contact: Permissions Manager BFW/Worth Publishers 33 Irving Place, 10th Floor New York, NY

2 KRUGMAN’S Economics for AP® S E C O N D E D I T I O N

3 Section 8 Module 45

4 What You Will Learn in this Module
Use macroeconomic models to conduct policy analysis Improve your approach to free-response macroeconomic questions Section 8 | Module 45

5 A Structure for Macroeconomic Analysis
Most macroeconomic problems have the following components: A starting point A pivotal event Initial effects of the event Secondary and long-run effects of the event How will the Fed’s monetary policy change nominal interest rates? Section 8 | Module 45

6 A Structure for Macroeconomic Analysis
For example: Assume the U.S. economy is currently operating at an aggregate output level above potential output. Draw a correctly labeled graph showing aggregate demand, short-run supply, long-run aggregate supply, equilibrium output, and the aggregate price level. Now assume that the Federal Reserve conducts contractionary monetary policy. Identify the open-market operation the Fed would conduct, and draw a correctly labeled graph of the money market to show the effect of the monetary policy on the nominal interest rate. Section 8 | Module 45

7 A Structure for Macroeconomic Analysis
Show and explain how the Fed’s actions will affect equilibrium in the aggregate demand and supply graph you drew previously. Indicate the new aggregate price level on your graph. Assume Canada is the largest trading partner of the United States. Draw a correctly labeled graph of the foreign exchange market for the U.S. dollar showing how the change in the aggregate price level you indicate on your graph above will affect the foreign exchange market. What will happen to the value of the U.S. dollar relative to the Canadian dollar? How will the Federal Reserve’s contractionary monetary policy affect the real interest rate in the United States? Explain. Section 8 | Module 45

8 The Starting Point Assume the U.S. economy is currently operating at an aggregate output level above potential output. Draw a correctly labeled graph showing aggregate demand, short-run supply, long-run aggregate supply, equilibrium output, and the aggregate price level. Section 8 | Module 45

9 Analysis Starting Points
Figure caption: Figure Panels (a, (b), and © represent the three basic starting points for analysis using the aggregate demand-aggregate supply model. Section 8 | Module 45

10 Analysis Starting Points
Figure caption: Figure Panels (a, (b), and © represent the three basic starting points for analysis using the aggregate demand-aggregate supply model. Section 8 | Module 45

11 The Balance of Payments
Figure caption: Figure Panels (a, (b), and © represent the three basic starting points for analysis using the aggregate demand-aggregate supply model. Section 8 | Module 45

12 The Pivotal Event Now assume that the Federal Reserve conducts contractionary monetary policy. Section 8 | Module 45

13 The Pivotal Event Section 8 | Module 45

14 The Pivotal Event Section 8 | Module 45

15 The Pivotal Event Section 8 | Module 45

16 The Pivotal Event Section 8 | Module 45

17 The Pivotal Event Section 8 | Module 45

18 The Initial Effect of the Event
Show and explain how the Fed’s actions will affect equilibrium. Section 8 | Module 45

19 Monetary and Fiscal Policy Close Output Gaps
Figure Caption: Figure By shifting the aggregate demand curve, monetary and fiscal policy can close output gaps in the economy as shown in panel (a) for a recessionary gap and panel (b) for an inflationary gap. Section 8 | Module 45

20 Secondary and Long-Run Effects of the Event
Assume Canada is the largest trading partner of the United States. What will happen to the value of the U.S. dollar relative to the Canadian dollar? How will the Federal Reserve’s contractionary monetary policy affect the real interest rate in the United States? Section 8 | Module 45

21 Analyzing Our Scenario
Section 8 | Module 45

22 Analyzing Our Scenario
Identify the open-market operation the Fed would conduct The Fed would sell U.S. Treasury securities (bonds, bills, or notes). Section 8 | Module 45

23 Analyzing Our Scenario
Draw a correctly labeled graph of the money market to show the effect of the monetary policy on the nominal interest rate. Section 8 | Module 45

24 Analyzing Our Scenario
Show and explain how the Fed’s actions will affect equilibrium in the aggregate demand and supply graph you drew previously. Indicate the new aggregate price level on your graph. A higher interest rate will lead to decreased investment and consumer spending, decreasing aggregate demand. The equilibrium price level and real GDP will fall. Section 8 | Module 45

25 Analyzing Our Scenario
Section 8 | Module 45

26 Analyzing Our Scenario
Draw a correctly labeled graph of the foreign exchange market for the U.S. dollar showing how the change in the aggregate price level you indicate on your graph above will affect the foreign exchange market. The decrease in the U.S. price level will make U.S. exports relatively inexpensive for Canadians to purchase and lead to an increase in demand for U.S. dollars with which to purchase those exports. Section 8 | Module 45

27 Analyzing Our Scenario
Section 8 | Module 45

28 Analyzing Our Scenario
What will happen to the value of the U.S. dollar relative to the Canadian dollar? The U.S. dollar will appreciate. How will the Federal Reserve’s contractionary monetary policy affect the real interest rate in the United States? Explain. There will be no effect on the real interest rate in the long run because, due to the neutrality of money, changes in the money supply do not affect values in the long run. Section 8 | Module 45

29 Summary Most macroeconomic problems have the following components:
A starting point A pivotal event Initial effects of the event Secondary and long-run effects of the event We can use the basic macroeconomic models to analyze scenarios and evaluate policy recommendations. Section 8 | Module 45


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