2.  Always draw a graph when in doubt!!!  Answer the questions you know first and then spend more time on the calculations or more time-consuming ones graph/charts)

3.  Identify- short word or phrase (1 sentence) to receive points (don’t write paragraphs)  Illustrate- draw or re-draw graphs (be sure to label all axes & all points (Q & P) OR (Y & PL)  Define- definition of concept (1-2 sentences)  Indicate- state what is expected to happen

4.  Use the 10 minute reading period to write notes (pre-write)- draw graphs & start outlining your ideas  Work in order a, b, c & d (each part will ask you to build on the prior one)  Be prepared for other graphs- Money market, money supply, etc to bring back the AD/AS graph

5.  Law of Demand (inverse relationship) As price increases, quantity demanded will decrease. As price decreases, quantity demanded will increase.  Law of Supply (direct relationship) As price increase, the quantity supplied will increase. As price decrease, the quantity supplied decreases.

6.  Opportunity Cost  Trade-offs  Inefficiency (inside curve) vs. efficiency (any point on the curve)  Growth (rightward shift in curve)

7. 2.The opportunity cost of moving from b to d is… 4.The opportunity cost of moving from f to c is… 3.The opportunity cost of moving from d to b is… 5.What can you say about point F? 6. What can you say about point G? 1. The opportunity cost of moving from a to b is… Example: Opportunity Cost 7

8. 2 Bikes 2.The opportunity cost of moving from b to d is… 4.The opportunity cost of moving from f to c is… 3.The opportunity cost of moving from d to b is… 7 Bikes 4 Computer 0 Computers 5.What can you say about point F? Inefficient 6. What can you say about point G? Unattainable 1. The opportunity cost of moving from a to b is… Example: Opportunity Cost 8

9.  Absolute advantage- producing a higher quantity given the same amount of resources  Comparative advantage- producing at a lower opportunity cost (must do calculation) FoodClothing Great Britain53 U.S.1512

10. 1. Which of the following statements must be true? A. The U.S. has both the absolute and comparative advantage in producing food. B. Japan has both the absolute and comparative advantage in producing food. C. The U.S. has both the absolute and comparative advantage in producing clothing. D. Japan has both the absolute and comparative advantage in producing clothing. E. Japan has the absolute advantage in producing soybeans and the comparative advantage in producing clothing.

11. 2. In the Japan, the opportunity cost of the first unit of A. Food is 1/3 units of clothing. B. Food is ¼ units of clothing. C. Clothing is 3 units of food. D. Clothing is 4 units of food. E. Clothing is 5 units of food.

12.  GDP = C + I + G + Nx (net exports = exports (goods going out of U.S.)- imports (goods coming into U.S.)

13. 1.Promote Economic Growth 2.Limit Unemployment 3.Keep Prices Stable (Limit Inflation) In this unit we will analyze how each of these are measured. For all countries there are three major economic goals: 13

14.  Economists collect statistics on production, income, investment, and savings.  This is called national income accounting. The most important measure of growth is GDP. Gross Domestic Product (GDP) is the dollar value of all final goods and services produced within a country’s borders in one year. Dollar value- GDP is measured in dollars. Final Goods-GDP does not include the value of intermediate goods. Intermediate goods are goods used in the production of final goods and services. One Year-GDP measures annual economic performance. 14

15. 2. Nonproduction Transactions Financial Transactions (nothing produced) Ex: Stocks, bonds, Real estate Used Goods Ex: Old cars, used clothes What is NOT included in GDP? 1.Intermediate Goods No Multiple Counting, Only Final Goods EX: Price of finished car, not the radio, tire, etc. 3. Non-Market (Illegal) Activities Ex: Illegal drugs, unpaid work 15

16. Calculating GDP Two Ways of calculating GDP: 1. Expenditures Approach-Add up all the spending on final goods and services produced in a given year. 2. Income Approach-Add up all the income that resulted from selling all final goods and services produced in a given year. Both ways generate the same amount since every dollar spent is a dollar of income. 16

17.  NRU- natural rate of unemployment (4-6%)  Frictional and cyclical unemp. is normal  Labor force = # ppl employed/# actively seeking work within last 6 weeks  Unemp rate = # ppl unemployed/# actively seeking work within last 6 weeks

18.  Nominal prices- are actual prices for that calendar year  Real prices- prices adjusted for inflation real interest rate = inflation + nominal

19. = Price of market basket in base year x 100 CPI Price of market basket Consumer Price Index (CPI) The most commonly used measurement inflation for consumers is the Consumer Price Index Here is how it works: The base year is given an index of 100 To compare, each year is given an index # as well 1997 Market Basket: Movie is $6 & Pizza is $14 Total = $20 (Index of Base Year = 100) 2009 Market Basket: Movie is $8 & Pizza is $17 Total = $25 (Index of ) 125 This means inflation increased 25% b/w ’97 & ‘09 Items that cost $100 in ’97 cost $125 in ‘09

20. Problems with the CPI 1.Substitution Bias- As prices increase for the fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket. (Result: CPI may be higher than what consumers are really paying) 2.New Products- The CPI market basket may not include the newest consumer products. (Result: CPI measures prices but not the increase in choices) 3.Product Quality- The CPI ignores both improvements and decline in product quality. (Result: CPI may suggest that prices stay the same though the economic well being has improved significantly)

21. Aggregate- the sum of the entire economy’s demand or supply Aggregate Demand & Supply

22. Shifters of Aggregate Demand Change in C onsumer Spending Change in I nvestment Spending Change in G overnment Spending Net E X port Spending AD = C + I + G + X Shifters of Aggregate Supply AS = P + A + I + R Change in R esource Prices Change in A ctions of the Government Change in P roductivity (Investment) 22 Change in I nflationary Expectations

23. Shifters of Aggregate Demand 1.Change in Consumer Spending Consumer Wealth (Boom in the stock market…) Consumer Expectations (People fear a recession…) Household Indebtedness (More consumer debt…) Taxes (Decrease in income taxes…) 2. Change in Investment Spending Real Interest Rates (Price of borrowing $) (If interest rates increase…) (If interest rates decrease…) Future Business Expectations (High expectations…) Productivity and Technology (New robots…) Business Taxes (Higher corporate taxes means…) 23

24. Shifters of Aggregate Demand 3.Change in Government Spending (War…) (Nationalized Heath Care…) (Decrease in defense spending…) 24 4.Change in Net Exports (X-M) Exchange Rates (If the us dollar depreciates relative to the euro…) National Income Compared to Abroad (If a major importer has a recession…) (If the US has a recession…) “If the US get a cold, Canada gets Pneumonia” AD = GDP = C + I + G + X n

25. Why is AD downward sloping? 1.Real-Balance Effect- Higher price levels reduce the purchasing power of money This decreases the quantity of expenditures Lower price levels increase purchasing power and increase expenditures Example: If the balance in your bank was $50,000, but inflation erodes your purchasing power, you will likely reduce your spending. So…Price Level goes up, GDP demanded goes down. 25

26. 2. Interest-Rate Effect When the price level increases, lenders need to charge higher interest rates to get a REAL return on their loans. Higher interest rates discourage consumer spending and business investment. WHY? Example: An increase in prices leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business. Result…Price Level goes up, GDP demanded goes down (and Vice Versa). 26 Why is AD downward sloping?

27. 3. Foreign Trade Effect When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods Exports fall and imports rise causing real GDP demanded to fall. (X N Decreases) Example: If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall. Again, Price Level goes up, GDP demanded goes down (and Vice Versa). 27 Why is AD downward sloping?

28. A major increase in productivity. Answer and identify shifter: C.I.G.X or P. A.I. R. 28

29. B A D A D B A A C A major increase in productivity. A Answer and identify shifter: C.I.G.X or P. A.I. R. 29

30. Price Level 30 AS Inflationary Gap GDP R LRAS QYQY AD 1 PL 1 Q1Q1 Output is high and unemployment is less than NRU Actual GDP above potential GDP

31. Price Level 31 AD GDP R QYQY PL 1 Q1Q1 LRAS AS 1 Recessionary Gap Output low and unemployment is more than NRU Actual GDP below potential GDP

32. Inflation 32 SRPC Short Run Phillips Curve Unemployment 2%9% 1% 5% What happens when AS falls causing stagflation? Increase in unemployment and inflation SRPC 1

33. Inflation 33 SRPC Short Run vs. Long Run Unemployment 2%9% 1% 5% What happens when AD falls? SRPC 1 3% 5% Long Run Phillips Curve In the long run wages fall and there is no tradeoff between inflation and unemployment What happens in the long run?

34. Price Level 34 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Show what happens on both graphs if AD increase AD 1

35. Price Level 35 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls? AD 1

36. Price Level 36 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Correctly draw the LRPC and SRPC at full employment. What happens when AS falls? AS 1 SRPC 1

37. Price Level 37 AD AS AD/AS and the Phillips Curve GDP R QYQY PL e LRAS Inflation SRPC Unemployment UYUY LRPC Correctly draw the LRPC and SRPC with an recessionary gap. What happens when AS goes up? AS 1 SRPC 1

38. How does the Government Stabilizes the Economy? The Government has two different tool boxes it can use: 1. Fiscal Policy- Actions by Congress to stabilize the economy. OR 2. Monetary Policy- Actions by the Federal Reserve Bank to stabilize the economy. 38

39. Two Types of Fiscal Policy Discretionary Fiscal Policy- Congress creates a new bill that is designed to change AD through government spending or taxation. Problem is time lags due to bureaucracy. Takes time for Congress to act. Ex: In a recession, Congress increase spending. Non-Discretionary Fiscal Policy AKA: Automatic Stabilizers Permanent spending or taxation laws enacted to work counter cyclically to stabilize the economy Ex: Welfare, Unemployment, Min. Wage, etc. When there is high unemployment, unemployment benefits to citizens increase consumer spending. 39

40. Laws that reduce inflation, decrease GDP (Close a Inflationary Gap) Decrease Government Spending Tax Increases Combinations of the Two Contractionary Fiscal Policy (The BRAKE) Laws that reduce unemployment and increase GDP (Close a Recessionary Gap) Increase Government Spending Decrease Taxes on consumers Combinations of the Two Expansionary Fiscal Policy (The GAS) How much should the Government Spend? 40

41.  Money multiplier= 1/MPS 1/.2= 1/1/5= 5

43. If the FED increases the money supply, a temporary surplus of money will occur at 5% interest. The surplus will cause the interest rate to fall to 2% Increasing the Money Supply Increase money supply Decreases interest rate Increases investment Increases AD 43 200 DMDM SMSM 10% 5% 2% Quantity of Money (billions of dollars) Interest Rate (ir) How does this affect AD? 250 S M1

44. If the FED decreases the money supply, a temporary shortage of money will occur at 5% interest. The shortage will cause the interest rate to rise to 10% Decreasing the Money Supply Decrease money supply Increase interest rate Decrease investment Decrease AD 44 200 DMDM SMSM 10% 5% 2% Quantity of Money (billions of dollars) Interest Rate (ir) How does this affect AD? 150 S M1

45. Showing the Effects of Monetary Policy Graphically 45 Three Related Graphs: Money Market Investment Demand AD/AS

46. Investment DemandS&D of Money The FED increases the money supply to stimulate the economy… 46 200 DMDM SMSM 10% 5% 2% Quantity M Interest Rate (i) 250 S M1 DIDI Quantity of Investment 10% 5% 2% Interest Rate (i) AD/AS QeQe AD AS GDP R PL AD 1 Q1Q1 PL e PL 1 1.Interest Rates Decreases 2.Investment Increases 3.AD, GDP and PL Increases

47. Investment DemandS&D of Money The FED decreases the money supply to slow down the economy… 47 200 DMDM SMSM 10% 5% 2% Quantity M Interest Rate (i) 175 S M1 DIDI Quantity of Investment 10% 5% 2% Interest Rate (i) AD/AS QeQe AD AS GDP R PL AD 1 Q1Q1 PL e PL 1 1.Interest Rates increase 2.Investment decreases 3.AD, GDP and PL decrease

48. Real Interest Rate 48 D Borrowers S Lenders Loanable Funds Market Quantity of Loans Q Loans rere At the equilibrium real interest rate the amount borrowers want to borrow equals the amount lenders want to lend.

49. Real Interest Rate 49 D Borrowers S Lenders Loanable Funds Market Quantity of Loans Q Loans D1D1 rere r1r1 Q1Q1 Example: The Gov’t increases deficit spending? Government borrows from private sector Increasing the demand for loans Real interest rates increase causing crowding out!!

50. 50 Loanable Funds Market 1.Changes in private savings behavior 2.Changes in public savings 3.Changes in foreign investment 4.Changes in expected profitability 1.Changes in perceived business opportunities 2.Changes in government borrowing Budget Deficit Budget Surplus Demand Shifters Supply Shifters

51. Money Multiplier Reserve Requirement (ratio) 1 = The Money Multiplier Example: If the reserve ratio is.20 and the money supply increases 2 Billion dollars. How much the money supply increase? 51 Example: Assume the reserve ratio in the US is 10% You deposit $1000 in the bank The bank must hold $100 (required reserves) The bank lends $900 out to Bob (excess reserves) Bob deposits the $900 in his bank Bob’s bank must hold $90. It loans out $810 to Jill Jill deposits $810 in her bank SO FAR, the initial deposit of $1000 caused the CREATION of another $1710 (Bob’s $900 + Jill’s $810)

52. Using Reserve Requirement 1. If there is a recession, what should the FED do to the reserve requirement? (Explain the steps.) 52 2. If there is inflation, what should the FED do to the reserve requirement? (Explain the steps.) Decrease the Reserve Ratio 1. Banks hold less money and have more excess reserves 2. Banks create more money by loaning out excess 3. Money supply increases, interest rates fall, AD goes up Increase the Reserve Ratio 1. Banks hold more money and have less excess reserves 2. Banks create less money 3. Money supply decreases, interest rates up, AD down

53. Practice Don’t forget the Monetary Multiplier!!!! 1.If the reserve requirement is.5 and the FED sells $10 million of bonds, what will happen to the money supply? 2.If the reserve requirement is.1 and the FED buys $10 million bonds, what will happen to the money supply? 3.If the FED decreases the reserve requirement from.50 to.20 what will happen to the money multiplier? 53

54. FOREIGN EXCHANGE

55. FOREX Supply and Demand Simplified Imagine a huge table with all the different currencies from every country This is the Foreign Exchange Market! Just like at a product market, you can’t take things without paying. If you demand one currency, you must supply your currency. Ex: If Canadians what Russian Rubles. The demand for Rubles in the FOREX market will increase and the supply of Canadian Dollars will increase.

56. $ D1D1 S1S1 Euros Quantity of Euros er 1 S er e D € $ Dollars Quantity of Dollars er 1 S er e D € What happens if Europeans prefer vacationing in the United States? The Dollar APPRECIATESThe Euro DEPRECIATES

57. 1. Changes in Tastes- Ex: British tourists flock to the U.S… Demand for U.S. dollars increases (shifts right) Supply of British pounds increases (shifts right) Pound-depreciates Dollar-appreciates 2. Changes in Relative Incomes (Resulting in more imports)- Ex: US growth increase US incomes…. U.S. buys more imports… U.S. Demand for pounds increases Supply of U.S. dollars increases Pound- appreciates Dollar- depreciates

58. 3. Changes in Relative Price Level (Resulting in more imports)- Ex: US prices increase relative to Britain…. U.S. demand for cheaper imports increases… U.S. demand for pounds increases Supply of U.S. dollars increases Pound- appreciates Dollar- depreciates 4. Changes in relative Interest Rates- Ex: US has a higher interest rate than Britain. British people want to put money in US banks Capital Flow increase towards the US British demand for U.S. dollars increases… British supply more pounds Pound-depreciates Dollar- appreciates

59. Pesos What will happen to the international value of the Mexican peso if there is high inflation in Mexico? The demand for pesos will decrease since Mexico's trading partners will not want to purchase higher priced Mexican products. The supply will increase as Mexicans look to buy lower priced imports. The peso DEPRECIATES

60. Practice For each of the following examples, identify what will happen to the value of US Dollars and Japanese Yen. 1.American tourists increase visits to Japan. 2.The US government significantly decreases personal income tax. 3.Inflation in the Japan rises significantly faster than in the US. 4.Japan has a large budget deficit that increases Japanese interest rates. 5.Japan places high tariffs on all US imports. 6.The US suffers a larger recession. 7.The US Federal Reserve sells bonds at high interest rates. How do these scenarios affect exports and imports?

61. Practice For each of the following examples, identify what will happen to the value of US Dollars and Japanese Yen. 1.USD depreciates and Yen appreciates 2.USD depreciates and Yen appreciates 3.USD appreciates and Yen depreciates 4.USD depreciates and Yen appreciates 5.USD depreciates (Demand Falls) and Yen appreciates (Supply Falls) 6.USD appreciates (Supply Falls) and Yen depreciates (Demand Falls) 7.USD appreciates and Yen depreciates Scenarios 1, 2, and 4 will increase US exports because US products are now relatively “cheaper”