1. Self Adjustment of AS & The Effect of an Interest Rate Change on the Price Level Interest Rates, Price Level AD/AS

2. Federal Reserve Bank of Atlanta Money and interest rates Money market graph: the supply and demand for money Quite simply, the interest rate is the price you pay to borrow or the price you charge for a loan. Demand for money Supply of money Nominal interest rate Quantity of moneyQ1 i1 0

3. Federal Reserve Bank of Atlanta Money and interest rates Money market graph: the supply and demand for money Quite simply, the interest rate is the price you pay to borrow or the price you charge for a loan. Demand for money Supply of money Nominal interest rate Quantity of moneyQ1 i1 Q2 0

4. Federal Reserve Bank of Atlanta Money and interest rates Money market graph: the supply and demand for money Quite simply, the interest rate is the price you pay to borrow or the price you charge for a loan. Demand for money Supply of money Nominal interest rate Quantity of moneyQ1 i1 Q2 i2 0

5. Federal Reserve Bank of Atlanta Money and interest rates Money market graph: the supply and demand for money If the demand for money the nominal interest rate decreases. Demand for money Supply of money Nominal interest rate Quantity of money i1 Q1 & Q2 i2 D2 0

6. Federal Reserve Bank of Atlanta Investment Demand The quantity demanded for investment dollars increases as the interest rate decreases. Investment in capital goods not financial investment. Demand for investment dollars interest rate (percent) Investment Dollars Q1 i1 Q2 i2 0

7. Federal Reserve Bank of Atlanta AD/AS Model AD=C+I+G+Xn Price Level Real GDP YE P1 Y SRAS LRAS 0

8. Federal Reserve Bank of Atlanta AD/AS Model i Qd investment AD Real GDP PL UE AD2=C+I+G+Xn Price Level Real GDP Y P1 YE P2 SRAS LRAS 0 AD1

9. Instructions for the 2010 Free Response Question #2: 1.Get in pairs 2.Answer question all parts a,b,c, and d for #2 on your slate. 3. Teacher will have one pair volunteer to share their answer with the group.

10. (a) 2 points: One point is earned for a correctly labeled graph of the money market. One point is earned for showing a downward shift of the money demand curve and showing a decrease in the nominal interest rate using arrows, labels or dotted lines. (b) 1 point: One point is earned for stating that bond prices will rise in the short run. (c) 2 points: One point is earned for stating that the price level will rise. One point is earned for the explanation that the price level increases because aggregate demand increases, and aggregate demand increases because interest- sensitive spending (investment, consumption or net exports) increases. (d) 1 point: One point is earned for stating that the Fed could sell bonds to decrease the money supply and raise the interest rate back to the original level.

11. Federal Reserve Bank of Atlanta Money and interest rates Money market graph: the supply and demand for money Quite simply, the interest rate is the price you pay to borrow or the price you charge for a loan. Demand for money Supply of money Nominal interest rate Quantity of money Q1 i1 0

12. Federal Reserve Bank of Atlanta Money and interest rates Money market graph: the supply and demand for money Quite simply, the interest rate is the price you pay to borrow or the price you charge for a loan. Demand for money Supply of money Nominal interest rate Quantity of moneyQ1 i1 0

13. Federal Reserve Bank of Atlanta Money and interest rates Money market graph: the supply and demand for money Quite simply, the interest rate is the price you pay to borrow or the price you charge for a loan. Demand for money Supply of money Nominal interest rate Quantity of money Q1 i1 i2 Q2 0

14. Federal Reserve Bank of Atlanta Investment Demand The quantity demanded for investment dollars decreases as the interest rate increases. Investment in capital goods not financial investment. Demand for investment dollars interest rate (percent) Investment Dollars Q1 i1 Q2 i2 0

15. Federal Reserve Bank of Atlanta AD/AS Model AD=C+I+G+Xn Price Level Real GDP YE P1 Y SRAS LRAS 0

16. Federal Reserve Bank of Atlanta AD/AS Model i Qd investment AD Real GDP PL UE AD=C+I+G+Xn 1 Price Level Real GDPY P1 YE P2 SRAS LRAS 0 AD2

17. Federal Reserve Bank of Atlanta AD/AS Model AD2 Price Level Real GDPY* P2 YE P1 SRAS1 LRAS 0 AD1 SRAS2 P3 Self Adjusting Aggregate Supply When economy is in long run equilibrium at YE: If AD The PL And RGDP PL unanticipated Real Wages (RW= Nominal Wage-PL) Pressure to raise wages If economy is left alone SRAS will PL will SRAS will adjust to LRAS at YE

18. Instructions for the 2010 Free Response Question #1: 1.Get in pairs 2.Answer question only parts a, b, and c for #1 on your slate. 3. Teacher will have one pair volunteer to share their answer with the group.

19. (a) 2 points: One point is earned for a correctly labeled graph with a downward- sloping AD curve, an upward-sloping SRAS curve, and the points PLE and YE on the vertical and horizontal axes. One point is earned for showing a vertical LRAS curve at YE. (b) 2 points: One point is earned for showing a rightward shift of the AD curve on the graph in part (a). One point is earned for stating that the unemployment rate would fall and explaining that this is because real output increases. (c) 2 points: One point is earned for stating that the short-run aggregate supply curve will shift to the left and showing PL2 correctly on the graph in part (a). One point is earned for explaining that the actual price level is higher than was expected or that wages and commodity prices adjust to the higher price level, causing the SRAS curve to shift to the left.