SUMMARY
Chapters: 25-29
Chapter 25
Money
anything that is generally accepted in payment for goods
or services or in the repayment of debts
Money is the set of assets in the economy that people
regularly use
to buy goods and services from each other.
Money is anything that can perform the functions:



Medium of exchange (used to pay for goods
and services)
Unit of account (used to measure value in the
economy)
Store of value (used as a repository of
purchasing power over time)
Chapter 25
Barter
the direct exchange of goods and services for other goods
and services.
Commodity monies
Items used as money that also have intrinsic value in some
other use.
Fiat, or token, money
Items designated as money that are intrinsically
worthless.
Chapter 25
Central Bank
an institution designed to oversee the banking system and
regulate the quantity of money in the economy.
The two most common measures of money are :
transactions money, also called M1, and
broad money, also called M2.
Exact classifications of M1 and M2 depend on the country.
M1 - Money that can be directly used for transactions.
M2 - M1 plus savings accounts, money market accounts,
and other near monies.
Chapter 26
interest
The fee that borrowers pay to lenders for the use
of their funds.
The total quantity of money demanded
in the economy is the sum:
demand for checking account balances
+
cash by both households and firms.
For both households and firms, the quantity of
money demanded at any moment depends on the
opportunity cost of holding money,
a cost determined by the interest rate.
Chapter 26
The demand for money depends negatively on the interest
rate, r, and positively on real income, Y,
and the price level, P.
Determinants of Money Demand
1
The interest rate: r (The quantity of money demanded is a negative
function of the interest rate.)
2 Aggregate nominal output (income) P • Y
a. Real aggregate output (income): Y (An increase in Y shifts the
money demand curve to the right.)
b. The aggregate price level: P (An increase in P shifts the money
demand curve to the right.)
Chapter 27
The goods market and the money market do not operate
independently.
The links between goods and money markets:
 The money market determines the interest rate. The
demand for money in the money market is affected by
income (which is determined in the goods market).
 The goods market determines income, which depends
on planned investment. Planned investment in turn
depends on the interest rate (which is determined in
the money market).
The key link between the two markets is the
interest rate…
Chapter 27
There is a negative relationship between planned
investment and the interest rate because the
interest rate affects the cost of investment
projects. When the interest rate rises, planned
investment decreases, and when the interest rate
falls, planned investment increases.
Chapter 27
In the goods market, there is a negative relationship between
the interest rate and output because there is a negative
relationship between the interest rate and planned investment.
In the money market, there is a positive relationship between
the interest rate and output for a fixed money supply because if
output increases, the interest rate must increase to achieve
equilibrium in the money market.
Chapter 27
Combining the goods and money markets determines the
equilibrium values of both the interest rate and output.
Equilibrium in the goods market (IS). Equilibrium in
financial markets (LM).
When the IS curve intersects the LM curve, both goods
and financial markets are in equilibrium.
Chapter 27

Expansionary Policy Effects:
expansionary fiscal policy - An increase in government
spending or a reduction in net taxes aimed at increasing
aggregate output (income) (Y).
G  Y  M d  r  I 

expansionary monetary policy - An increase in the money
supply aimed at increasing aggregate output (income) (Y).
Ms  r   I  Y  M d 


Contractionary Policy Effects:
contractionary fiscal policy - A decrease in government
spending or an increase in net taxes aimed at decreasing
aggregate output (income) (Y).
G  or T  Y  M d  r  I 
contractionary monetary policy - A decrease in the money
supply aimed at decreasing aggregate output (income) (Y).
M s  r  I  Y  M d 
Chapter 27
An expansionary fiscal policy based on increases in government
spending tends to lead to a crowding-out effect: Because
increased government expenditures mean more transactions in
the economy and thus an increased demand for money, the
interest rate will rise. The decrease in planned investment
spending that accompanies the higher interest rate will then
partially offset the increase in aggregate expenditures brought
about by the increase in G.
The size of the crowding-out effect, affecting the size of the
government spending multiplier, depends on two things: the
assumption that the Central Bank does not change the quantity
of money supplied and the sensitivity or insensitivity of planned
investment to changes in the interest rate.
policy mix
is the combination of monetary and fiscal
policies in use at a given time.
(Dışlama etkisi)
Devlet artan kamu harcamalarını finanse edebilmek için
piyasadan borçlanma gereği duyar. Bu da piyasada faiz
oranlarının artmasına neden olur. Artan faiz oranları
yatırımın maliyetini artırır. Kamu kâğıtlarına uygulanan
faizlerin yüksekliği fonları kamuya yöneltir. Özel sektör
yeterli ve uygun koşullarda fon bulamaz.
Chapter 27
The aggregate demand (AD) curve graphs the negative
relationship between aggregate output (income) and the
price level.
An increase in the quantity of money supplied, an increase in
government purchases, or a decrease in net taxes at a given
price level shifts the aggregate demand curve to the right.
A decrease in the quantity of money supplied, a decrease in
government purchases, or an increase in net taxes shifts the
aggregate demand curve to the left.
Chapter 27
Refer to the information provided in table below to answer the questions that follow:
A Hypothetical Investment Schedule
Interest rate %
2
4
6
8
10
12
Planned Investment
($ Billion)
450
420
390
360
330
300
1. If the interest rate dropped from 10% to 4%, planned investment would __ by $ __ billion.
A. Increase; 90
B. Increase; 60
C. decrease; 90
D. decrease; 60
420-330=90
2. Suppose the expenditure multiplier is 3. A drop in the interest rate from 12% to 6%, ceteris
paribus, would increase equilibrium output by $ ____ billion.
A. 180
B. 120
C. 270
D. 160
Multiplier=∆Y/∆I ; ∆I =390-300=90; ∆Y=90x3=270
3. Suppose the expenditure multiplier is 4 and the initial interest rate is 8%. A move to what
interest rate will increase equilibrium output by 240 billion?
A. 4
B. 6
C. 10
D. 12
∆I = 240/4=60; 360-60=300
Chapter 28
The Aggregate Supply Curve
Aggregate supply
is the total supply of goods and services in an economy.
The aggregate supply (AS) curve shows the relationship
between the aggregate quantity of output supplied by all
the firms in an economy and the overall price level.
The AS curve is not a market supply curve, and it is not
the simple sum of all the individual supply curves in the
economy.
Chapter 28
Short run Aggregate Supply
Curve
In the short run, the aggregate
supply curve (the price/output
response curve) has a positive
slope.
Long run Aggregate Supply
Curve
If wages fully adjust to prices
in the long run, then the long
run AS curve will be vertical.
The level of aggregate output
that can be sustained in the long
run without inflation is called
potential output or potential
GDP.
Chapter 28
The Equilibrium Price Level
The equilibrium price level in the economy occurs at the point at
which the AS and AD curves intersect. The intersection of the
AS and AD curves corresponds to equilibrium in the goods and
money markets and to a set of price/output decisions on the
part of all the firms in the economy.
Chapter 28
Monetary and Fiscal Policy Effects
If the economy is initially producing on the flat portion of
the AS curve, an expansionary policy—which shifts the
AD curve to the right—will result in a small increase in
the equilibrium price level relative to the increase in
equilibrium output.
If the economy is initially producing on the steep portion
of the AS curve, an expansionary policy results in a small
increase in equilibrium output and a large increase in the
equilibrium price level.
If the AS curve is vertical in the long run, neither
monetary nor fiscal policy has any effect on aggregate
output in the long run. For this reason, the exact length
of the long run is one of the most pressing questions in
macroeconomics.
Chapter 28
CAUSES OF INFLATION
Demand-pull inflation is inflation initiated by an increase
in aggregate demand.
Cost-push, or supply-side, inflation is inflation initiated by
an increase in costs like energy prices.
An increase in costs may also lead to
stagflation
the situation in which the economy is experiencing a
contraction and inflation simultaneously.
inflation targeting
When a monetary authority chooses its interest rate values with
the aim of keeping the inflation rate within some specified band
over some specified horizon.
Chapter 29
The Labor Market: Basıc Concepts
Because the economy is dynamic, frictional and structural
unemployment are inevitable and in some ways desirable.
Times of cyclical unemployment are of concern to
macroeconomic policy makers.
In general, employment tends to fall when aggregate
output falls and rise when aggregate output rises.
Chapter 29
THE CLASSICAL VIEW OF THE LABOR MARKET
Classical economists believe that the interaction of
supply and demand in the labor market brings about
equilibrium and that unemployment (beyond the frictional
and structural amounts) does not exist.
The classical view of the labor market is
consistent with the theory of a vertical
aggregate supply curve.
Chapter 29
EXPLAINING THE EXISTENCE OF UNEMPLOYMENT
Some economists argue that the unemployment rate is not an
accurate indicator of whether the labor market is working
properly.
Those who do not subscribe to the classical view of the labor
market suggest several reasons why unemployment exists.
 Sticky wages
 Efficiency wage theory
 Imperfect Information
 Minimum wage laws
Chapter 29
THE SHORT-RUN RELATIONSHIP BETWEEN THE
UNEMPLOYMENT RATE AND INFLATION
There is a negative relationship between the
unemployment rate (U) and aggregate output (income) (Y):
When Y rises, U falls. When Y falls, U rises.
The relationship between the unemployment rate and the
price level is negative: As the unemployment rate declines
and the economy moves closer to capacity, the price level
rises more and more.
Chapter 29
The Phillips Curve
The Phillips Curve represents the relationship between
the inflation rate and the unemployment rate.
During the 1950s and 1960s, this relationship was stable and
there seemed to be a predictable trade-off between inflation
and unemployment. As a result of import price increases (which
led to shifts in aggregate supply), the relationship between the
inflation rate and the unemployment rate was erratic in the
1970s. Inflation depends on more than just the unemployment
rate.
Chapter 29
THE LONG-RUN AGGREGATE SUPPLY CURVE,
POTENTIAL OUTPUT, AND THE NATURAL RATE OF
UNEMPLOYMENT
Those who believe that the AS curve is vertical in the
long run also believe that the Phillips Curve is vertical in
the long run at the natural rate of unemployment. The
natural rate is generally the sum of the frictional and
structural rates.
The NAIRU (Nonaccelerating Inflation Rate of
Unemployment) theory says that the price level will
accelerate when the unemployment rate is below the
NAIRU and decelerate when the unemployment rate is
above the NAIRU.
Chapter 29
Refer to the information provided in figure below to answer the question that follow.
1. The equilibrium wage rate is $________ and the equilibrium number of people
employed is ________ million people.
A. 13; 100
B. 7; 160
C. 4; 130
D. 13; 220
2. At wage rate $13, there is a ________ of labor equal to ________ million people.
A. Surplus; 100
B. Shortage; 100
C. Shortage; 120
D.Surplus; 120
3. At wage rate $4, there is a ________ of labor equal to ________ million people.
A. Shortage; 120 B. Shortage; 60
C. Surplus; 120
D. Surplus; 60