PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unattainable
A
B
C
W
Attainable
& Efficient
D
Attainable
but
Inefficient
E
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
A’
13
12
11
10
9
8
7
6
5
4
3
2
1
Economic
Growth
C’
B’
D’
E’
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Curve For Each Country
United States
Brazil
45
40
30
Coffee (tons)
Coffee (tons)
35
25
20
15
10
30
25
20
15
10
A
5
5
B
0
0
5
10
15
20
Wheat (tons)
25
30
5
10
15
20
Wheat (tons)
TRADING POSSIBILITIES LINES
The Gains from Trade
United States
Brazil
45
40
Trading
possibilities line
30
Coffee (tons)
Coffee (tons)
35
25
20
15
A’
10
30
25
20
Trading
possibilities line
15
10
A
5
B’
5
B
0
0
5
10
15
20
Wheat (tons)
25
30
5
10
15
20
Wheat (tons)
MARKET DEMAND &
SUPPLY
Price of Corn
P
S
$5
4
Market
Clearing
Equilibrium
3
2
1
o
D
2
4
6
78
10 12 14 16
Quantity of Corn
Q
MARKET DEMAND &
SUPPLY
Price of Corn
P
S
$5
At a $2 price
4
more is being
3
demanded than
supplied
2
Shortage
1
o
D
2
4
6
78
101112 14 16
Quantity of Corn
Q
MARKET DEMAND &
SUPPLY
Price of Corn
P
$5
Surplus
S
At a $4 price
4
more is being
3
supplied than
demanded
2
1
o
D
2
4
6
78
10 12 14 16
Quantity of Corn
Q
£1 : $1
£2 : $1
£/$
2/1=2
Dollar
depreciates /
Pound
appreciates
£1 : $1
£1 : $2
£.5 : $1
£/$
1 / 2 = .5
.5/ 1 = .5
P
Price of Dollar in Pound (£ / $)
Dollar
appreciates /
Pound
depreciates
THE MARKET FOR CURRENCY
EXCHANGE
RATE: £1 = $1
S
2
1
Dollar
appreciates
Dollar
depreciates
.5
D
Quantity of Dollar
Q
Loanable Funds Market
i
Demand for
Loanable
Funds
Supply of
Loabable
Funds
3
Real interest rate
•Businesses
•Government
Slf
2
1
•Households
Dlf
Quantity of loanable funds
Qlf
Bond Market
Demand for
Bonds
•Households
Supply of
Bonds
•Businesses
•Government
Price of Bonds
Pb
Sb
3
2
1
Db
Quantity of bonds
Qb
Rate of interest, i (percent)
THE MONEY MARKET
A temporary surplus
of money will require
Sm1 Sm Sm2 the purchase of some
assets to meet the desired level of liquidity.
10
7.5
ie
5
2.5
Dm
0
0
50
100
150
200 250 300
Amount of money demanded
(billions of dollars)
A temporary
shortage
of money will
require
the sale of some
assets
to meet the
need.
Average and Marginal Propensities
APC
Consumption / Disposable Income
APS
Saving / Disposable Income
MPC
Change in Consumption
Change in Disposable Income
MPS
Change in Saving
Change in Disposable Income
INVESTMENT
and interest rate, i (percents)
Expected rate of return,
r,
16
14
INVESTMENT
DEMAND
CURVE
12
10
8
6
4
2
ID
0
5
10
15
20
25
30
35
40
Investment (billions of dollars)
THE MULTIPLIER EFFECT
Multiplier
=
1
1
or
1 - MPC
MPS
Inverse relationship between
Multiplier & MPS
Change
in GDP
= Multiplier x
initial change
in spending
AGGREGATE DEMAND
Price level
Aggregate Demand
Increases
Aggregate Demand
Decreases
AD2
AD3
AD1
Real domestic output, GDP
DETERMINANTS OF AGGREGATE DEMAND
Change in Consumer Spending
• Consumer Wealth
• Consumer Expectations
• Consumer Indebtedness
• Taxes
Change in Investment Spending
• Real Interest Rates
• Expected Returns
• Expected Future Business
Conditions
• Technology
• Degree of Excess Capacity
• Business Taxes
DETERMINANTS OF AGGREGATE DEMAND
Government Spending
Net Export Spending
• National Income Abroad
• Exchange Rates
Changes in Aggregate Demand Shifts
and the Aggregate Expenditures Model
Illustrated…
AGGREGATE SUPPLY
Price level
AS3AS1AS2
Decrease In
Aggregate
Supply
Increase In
Aggregate
Supply
Real domestic output, GDP
DETERMINANTS OF AGGREGATE SUPPLY
Change in Input Prices
Domestic Resource
Availability
• Land
• Labor
• Capital
• Entrepreneurial Ability
Prices of Imported Goods
Market Power
DETERMINANTS OF AGGREGATE SUPPLY
Change in Productivity
Productivity
=
Real Output
Input
Change in Legal-Institutional
Environment
• Business Taxes and
Subsidies
• Government Regulation
Price Level
Equilibrium output short of full employment
LRAS
AS
PLe
AD
ye Yfe
Real Domestic Output, GDP
Price Level
SHORT-RUN AGGREGATE SUPPLY
A lower price
level
decreases
profits and
output
moving the
economy
from a1 to a3
SRAS
P2
a2
P1
P3
o
A higher
price level
increases
profits and
output
moving the
economy
from a1 to
a2
a1
a3
Q3
Q1
Q2
Real domestic output
LONG RUN AGGREGATE SUPPLY
A higher price level results in higher nominal wages and
thus shifts the short-run aggregate supply to the left
Price
Level
ASLR
Short Run -
b1
P2
Period in which
nominal wages (and
other input prices)
remain
P1
fixed as the price level
increases or decreases
AS2
AS1
a2
AS3
a1
Long Run Period in which
nominal wages are
fully responsive to
previous changes in
the price level
P3
o
a3
Q3
c1
Q1
Q2
Real domestic output
A lower
price level
results in
lower
nominal
wages
and shifts
the shortrun
aggregate
supply to
the right
Equilibrium output at full employment
LRAS
Price Level
SRAS
PL1
a
AD
o
YFE
Real domestic output
THE DEMAND FOR MONEY
10
7.5
5
2.5
Dt
0
0 50 100 150 200 250 300
Amount of money
demanded (billions
of dollars)
Asset
Demand, Da
=
10
7.5
5
2.5
Da
Total demand
for money, Dm
Nominal interest rate, i (percent)
+
Nominal interest rate, i (percent)
Nominal interest rate , i (percent)
Transactions
Demand, Dt
10
7.5
5
2.5
Dm
0
0 50 100 150 200 250 300
0
0 50 100 150 200 250 300
Amount of money
demanded (billions
of dollars)
Amount of money
demanded (billions
of dollars)
Nominal interest rate , i (percent)
THE MONEY MARKET
Sm
10
7.5
ie
5
Dm
2.5
0
0
50
100
150
200 250 300
Amount of money demanded
(billions of dollars)
THE PHILLIPS CURVE
PCLR
Normally, there is
a trade off
between the rate
of inflation and
the rate of
unemployment
(PC)
Aggregate supply
shocks can cause
both higher rates
of inflation and
higher rates of
unemployment
(shift from PC to
PC1)
Annual rate of inflation (percent)
7
There is no
significant trade
off between
inflation and
unemployment
over the long run
(PCLR)
6
5
4
3
2
PC1
1
PC
0
1
2
3
4
5
6
7
Unemployment rate (percent)
THE LAFFER CURVE
Tax rate (percent)
100
n
m
m
Maximum
Tax
Revenue
l
0
Tax revenue (dollars)