The difference between a
change in demand and a
change in quantity
demanded
GRAPHING DEMAND
Price of Corn
P
CORN
P
$5
4
3
2
1
QD
10
20
35
55
80
$5
4
3
2
What if
Demand
Increases?
1
o
D
10 20 30 40 50 60 70 80
Quantity of Corn
Q
GRAPHING DEMAND
Price of Corn
Increase
in Quantity
Demanded
P
CORN
P
$5
4
3
2
1
QD
10 30
20 40
35 60
55 80
80 +
$5
4
3
2
1
o
Increase
in
Demand
10 20 30 40 50 60 70 80
Quantity of Corn
D’
D
Q
The difference between a
change in supply and a
change in quantity
demanded
GRAPHING SUPPLY
Price of Corn
P
$5
4
3
2
S
What if
Supply
Increases?
1
o
10 20 30 40 50 60 70 80
Quantity of Corn
CORN
P QS
$5
4
3
2
1
Q
60
50
35
20
5
GRAPHING SUPPLY
Price of Corn
P
$5
4
3
2
1
Increase
in
Supply
S
S’
CORN
P QS
$5
4
3
Increase 2
in Quantity 1
Supplied
o
10 20 30 40 50 60 70 80
Quantity of Corn
Q
60 80
50 70
35 60
20 45
5 30
Mislabeling or NOT
labeling graphs correctly
EQUILIBRIUM AND CHANGES
IN EQUILIBRIUM
Price Level
P
LRAS
AS
Equilibrium
Real Output
P
AD
Y
Real Domestic Output, GDP
Q
GROWTH IN THE AD-AS MODEL
ASLR1 ASLR2
C
Price Level
Capital Goods
A
B
D
Consumer Goods
Q1 Q2
Real GDP
THE MONEY MARKET
Nominal Interest Rate
Sm1
Sm Use this graph when the
FED changes the money
supply to change interest
rates.
10
7.5
ie
5
Dm
2.5
0
0
50
100
150
200 250 300
Amount of money demanded
(billions of dollars)
Net effects of Monetary
Policy and/or Fiscal Policy on
Interest Rate
Expansionary Fiscal Policy
= Interest Rate INCREASE
• Exp. Fiscal Policy (Gov’t deficit) 
Increase Demand for Money  Increase
Interest Rate.
• Higher Price Level Increase Demand for
Money Increase Interest Rate.
Expansionary Monetary Policy
 Interest Rate DECREASE
MONETARY POLICY AND EQUILIBRIUM GDP
Nominal interest rate
Sm1 S
m2
10
10
8
8
6
6
Investment
Demand
Dm
0
0
Quantity of money
Amount of investment, I
Price level
AS
P2
P1
AD1
AD2
Real domestic output, GDP
Money Supply Increases
If the money
Interest Rate Decreases
supply increases
Investment
Increases
to stimulate
the
economy...
AD &
GDP Increases
with slight inflation
MONETARY POLICY AND EQUILIBRIUM GDP
Real rate of interest, i
Sm1 S S
m2
m3
10
10
8
8
6
6
Dm
0
Quantity of money demanded and supplied
AS
Price level
Investment
Demand
P3
P2
P1
0
Amount of investment, i
More Money Supply
If theInterest
moneyRates
Lower
supply increases
More Investment
again…
AD1
AD2 AD3
Real domestic output, GDP
Still higher AD & GDP
with significant inflation
MULTIPLIER(S) CONFUSION
THE MULTIPLIER EFFECT
Multiplier
Change in
GDP
1
1
or
1 - MPC
MPS
=
= Multiplier x
initial change
in spending
MPC and the Multiplier
MPC
Multiplier
.9
10
.8
5
.75
4
.67
.5
3
2
MONEY MULTIPLIER
•
1 / Required Reserve Ratio
• Maximum Multiple $$$ Money Expansion
MULTIPLE DEPOSIT EXPANSION PROCESS
Bank
Acquired reserves Required
and deposits
reserves
Excess
reserves
Amount bank
can lend - New
money created
$80.00
64.00
51.20
40.96
32.77
26.22
20.98
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.57
Total amount of money created by the banking system $400.00
A
$100.00
B
80.00
C
64.00
D
51.20
E
40.96
F
32.77
G
26.22
H
20.98
I
16.78
J
13.42
K
10.74
L
8.59
M
6.87
N
5.50
Other banks 21.97
$20.00
16.00
12.80
10.24
8.19
6.55
5.24
4.20
3.36
2.68
2.15
1.72
1.37
1.10
4.40
$80.00
64.00
51.20
40.96
32.77
26.22
20.98
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.57
Balanced Budget
Multiplier= 1
(Net Result on GDP)
FEDERAL RESERVE PURCHASE
OF BONDS FROM PUBLIC
Purchase of a
$1000 bond
from public...
New reserves
$800
Excess
Reserves
$4000
Bank System Lending
$200
Required
reserves
$1000
Initial
Deposit
Total Increase in Money Supply ($5000)
Someone deposits $1000 in new
Reserves at a bank.
New reserves
$800
Excess
Reserves
$4000
Bank System Lending
$200
Required
reserves
$1000
Initial
Deposit
Total Increase in Money Supply ($4000)
Fed Buys A $1,000 Bond From Joe’s Bank
New reserves
$1,000
20% RR
Excess
Reserves
$5,000
PMC thru Bank Lending
TMS
is
$5000
OUTCOME OF MONEY EXPANSION
$100
New reserves
$80
Excess
reserves
$20
Required
reserves
Leakages
exist...(Savings)
Currency
Drains
$100
$400
Initial
Bank system
lending Deposit
Excess
Reserves
Money Created
$100
New reserves
Injections:
$80
Excess
reserves
$20
Required
reserves
Additional Spending into
Income – Expenditures stream:
Investment,
$100
G, or
Xn
$400
Bank system lending
Money Created
Initial
Deposit
UNEMPLOYMENT
Types of Unemployment
Frictional Unemployment
Structural Unemployment
Cyclical Unemployment
Natural rate of Unemployment =
Structural + Frictional (Around 4-5%)
LOANABLE FUNDS MARKET
real interest rate
S
This graph shows
how the supply and
demand for loanable
funds affects real
interest rates
r
D
Q
Quantity of Loanable Funds
Loanable Funds Market Graph
(Long-Term Interest Rates)
What changes Supply:
1. Increase in Household
savings
2. Increase in Gov’t
savings
3. Increase in Business
savings
4. Increase in Business
savings
5. Increase in Foreigners’
savings
What changes Demand:
1. Increase in Household
borrowing
2. Increase in business
Investment
3. Increase in Foreign
borrowing
4. Increase in Government
borrowing (When the
gov’t has a budget
deficit!) = (the crowding out effect)
Price Index
Price Index
Price of market basket in specific year
in a given = --------------------------------------------X 100
Year
Price of same market basket in base year
Real GDP =
Nominal GDP
------------------------------Price Index
X 100
Remembering the
difference between
Real
and
Nominal
Nominal:
with Inflation
Real:
Adjusted for Inflation
Nominal vs. Real
11%
=
+
5%
Nominal
Interest
Rate
Real
Interest
Rate
6%
Inflation
Premium
Real Interest Rate
[Nominal I.R. – inflation rate = Real I.R.]
16%
-
6
%
Nominal Inflation
Interest Premium
Rate
=
10
%
Real
Interest
Rate
Demand-Pull Inflation
vs.
Cost-Push Inflation
DEMAND-PULL INFLATION
ASLR
AS2
Price Level
AS1
c
P3
b
P2
a
P1
AD2
AD1
o
Q1
Real domestic output
COST-PUSH INFLATION
Occurs when short-run AS shifts left
ASLR
AS2
Price Level
AS1
b
P2
a
P1
AD1
o
Q2 Q1
Real domestic output
COST-PUSH INFLATION
Government response with increased AD
ASLR
AS2
Price Level
AS1
c
P3
b
P2
a
P1
Even
higher
price
levels
AD2
AD1
o
Q2 Q1
Real domestic output
COST-PUSH INFLATION
ASLR
AS2
Price Level
AS1
b
P2
a
P1
AD1
o
Q2 Q1
Real domestic output
COST-PUSH INFLATION
If government allows a recession to occur
ASLR
AS2
Price Level
AS1
b
P2
a
P1
Nominal
wages fall (which
increases AS &
AS returns
to its original
location
AD1
o
Q2 Q1
Real domestic output
People must believe Fed is serious
about stopping inflation. Higher
expectations decreases Aggregate
Supply.
THE PHILLIPS CURVE CONCEPT
Annual rate of inflation
(percent)
7
As inflation declines...
6
5
Unemployment
increases
4
3
2
1
0
1
2
3
4
5
6
7
Unemployment rate (percent)
THE PHILLIPS CURVE CONCEPT
LRPC = Natural Rate of
Unemployment
Annual rate of inflation
(percent)
7
6
5
4
3
2
1
0
1
2
3
4
5
6
7
Unemployment rate (percent)
GENERAL EXAM ADVICE
Free Response:
• Do not restate question
• Use correct terminology
• Even if a graph is not required, draw
one anyway and explain.
• Use same outline as question
• Use Good Handwriting
GENERAL EXAM ADVICE
• Draw graphs large enough for the
reader to tell what’s going on.
• Explain your reasoning: “the price
increased”, why?
• No Calculators