1. TEST REVIEW
MACRO UNIT-3

2. Unit #3 Key Graphs
AS/AD Model
PPF

3. 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!

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

5. 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

6. 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)

7. 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

8. 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

9. 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)

10. 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)

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

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