1. Production Possibilities Curve
2. Supply
3. Demand
4. Dollars market/currency
5. Money market
6. Loanable Funds
7. Phillips Curve
8. Ceiling
9. Floor
10. ADAS with SRAS and LRAS
1.
2.
3.
4.
5.
6.
7.
Production Possibilities Frontier
Supply and Demand
Currency Market
AD-AS Model
Loanable Funds Model
Phillips Curve
Money Market
1
Production Possibilities Graph
• Assumptions:
– Full Employment
– Fixed Resources and Technology
• Movements
– Along curve shows opportunity cost
– Outward shift illustrates economic growth
– Inward shift indicates destruction of resources
• Producing Capital Goods will lead to greater economic
growth than producing consumer goods. (Butter will
lead to more growth than guns)
Production Possibilities Graph
Capital
Goods
Points A,B,C, are efficient pts.
Point D is underutilization
Point E is economic growth
A
May Lead to most
Future economic growth
E
B
D
C
Consumer Goods
2
Supply and Demand
• Demand Changes when:
– Income changes
– Related Products, complements and substitutes,
(price or quality change)
– Expectations (future price change)
– Consumers (more or less added)
– Tastes, Fads, Preferences change
Demand Increase: As Demand Increases, Price and
Quantity Increase as well.
Price
S1
P2
P1
D2
D1
Q1
Q2
Quantity
Demand Decrease: As Demand Decreases, Price and
Quantity decrease as well
Price
S1
P1
P2
D1
D2
Q2
Q1
Quantity
• Supply Changes When:
– Input prices change (resources and wages)
– Government (tariffs, quotas, and subsidies)
– Number of sellers change
– Expectations (about price and product profitability
change)
– Disasters (weather, strikes, etc..)
Supply Increase: As Supply Increases, Quantity
Increases, but Price Falls.
S1
Price
S2
P1
P2
D1
Q1
Q2
Quantity
Supply Decrease: As Supply Decreases, Quantity
Decreases, but Price Increases.
S2
Price
S1
P2
P1
D1
Quantity
Q2
Q1
Price Floor
1. Price set above
equilibrium
2. Producers produce
too much
3. Consumers
demand less than
what is produced
4. Surplus created –
Qs > Qd
D
S
P
P
Surplus
Qd
Price Ceiling
1. Price set below
equilibrium
2. Consumers
demand too much
3. Producers produce
too little
4. Shortage created –
Qd > Qs
D
S
P
P
Shortage
Qs
Qd
Qd
3
Currency Market
Currency Terms
• Appreciation: Currency is increasing in
demand (stronger dollar)
– U.S. Currency will appreciate when
• more foreigners: travel to the U.S.,
• buy more U.S. goods or services, or
• buy the U.S. dollar to invest in bonds
Currency Terms
• Depreciation: Currency is decreasing in
demand (weaker dollar) Being SUPPLIED
in exchange for other currency.
– U.S. Currency will depreciate when fewer
foreigners: travel to the U.S., buy fewer
U.S. goods or services, or sell the U.S.
dollar to invest in their own bonds
4
AD-AS Model
Aggregate Demand
Downward sloping:
1. Real-Balances Effect: change
in purchasing power
Price
Level
2. Interest-Rate Effect: Higher
interest rates curtail spending
3. Foreign Purchase Effect:
Substitute foreign products for
U.S. products
AD (C + I + G + X)
Real GDP
Aggregate Demand
• Determinants of AD:
– C + I + G + Nx
– An increase in any of these will increase AD and shift
the curve to the right.
– A decrease in any of these will cause a decrease in AD
and shift the curve to the left
Aggregate Demand Determinants
• Consumption
–
–
–
–
Wealth
Expectations
Debt
Taxes
• Investment
– Interest Rates
– Expected Returns
• Technology
• Inventories
• Taxes
• Government
– Change in Gov. spending
• Net Exports
– National Income Abroad
– Exchange Rates
Aggregate Supply Factors:
• R: resource prices (wages and materials,
as well as OIL)
• A: actions by government (Taxes,
Subsidies, more regulation)
• P: productivity (better technology)
Aggregate Supply
• Short Run:
– Assumes that nominal wages
are “sticky” and do not
respond to price level
changes.
– Is Upward sloping as
businesses will increase
output to maximize profits
• Long Run:
– Curve is vertical because the
economy is at its fullemployment output.
– As prices go up, wages have
adjusted so there is no
incentive to increase
production.
LRAS
SRAS
P
AD
Y
Real GDP or Real output or Real income
Recessionary Gap
Inflationary Gap
5
Loanable Funds
Loanable Funds Market
Demand for Loanable Funds
Loanable funds are used for three purposes
1. Business Investment
2. Government deficit financing
3. International Investment or lending
Demand for Loanable Funds Curve
The demand for loanable funds shows the relationship between the real interest rate
and the quantity of loanable funds demanded. It shows that the quantity of loanable
funds will be lower at a high real interest rate than at a lower real interest rate.
Loanable Funds Market
Supply of Loanable Funds
Loanable funds come from three places
1. Private savings
2. Governmental budget surpluses
3. International borrowing
Supply of Loanable Funds Curve
i
6%
4%
40
60
LF
Equilibrium in the Loanable Funds Market
Shifts in Demand for Loanable Funds
The major determinant of the demand for loanable funds is expected profit. When
the expected profit changes, the demand for loanable funds changes. The greater
the expected profit of new capital, the greater is the amount of investment and the
greater is the demand for loanable funds. When the expected profit increases and
we earn more from our investment, the more affordable it becomes to borrow
loanable funds – even when the interest rate.
Shifts in Supply of Loanable Funds
1. Disposable income (shifts the supply of
loanable funds)
2. Wealth (shifts the supply of loanable
funds)
3. Expected future income (shifts the supply
of loanable funds)
4. Default risk (shifts the supply of loanable
funds)
6
Phillips Curve
7
Money Market