1.Production Possibilities Frontier 2.Supply and Demand 3.Currency Market 4.AD-AS Model 5.Loanable...

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. Production Possibilities Frontier2. Supply and Demand3. Currency Market4. AD-AS Model5. Loanable Funds Model6. Phillips Curve7. Money Market

1

• 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

Production Possibilities Graph

Capital Goods

Consumer Goods

A

B

CD

E

Points A,B,C, are efficient pts.Point D is underutilizationPoint E is economic growth

May Lead to mostFuture growth

May Lead to mostFuture economic growth

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.

P1

P2

Q1 Q2

S1

D1

D2

Price

Quantity

Demand Decrease: As Demand Decreases, Price and Quantity decrease as well

D1

D2

S1

P1

P2

Q1Q2

Price

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.

Price

QuantityQ1 Q2

P1

P2

S1S2

D1

Supply Decrease: As Supply Decreases, Quantity Decreases, but Price Increases.

Price

Quantity

S1

S2

D1

P1

P2

Q1Q2

P

Qd

SD

Price Floor

P

Surplus

1. Price set above equilibrium

2. Producers produce too much

3. Consumers demand less than what is produced

4. Surplus created – Qs > Qd

P

Qd

SD

Price Ceiling

Shortage

P

QdQs

1. Price set below equilibrium

2. Consumers demand too much

3. Producers produce too little

4. Shortage created – Qd > Qs

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

AD (C + I + G + X)

PriceLevel

Real GDP

Downward sloping:1. Real-Balances Effect: change in purchasing power

2. Interest-Rate Effect: Higherinterest rates curtail spending

3. Foreign Purchase Effect: Substitute foreign products for U.S. products

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 full-employment output.

– As prices go up, wages have adjusted so there is no incentive to increase production.

Real GDP or Real output or Real income

Recessionary Gap

Inflationary Gap

5 Loanable Funds

Loanable Funds Market

Loanable funds are used for three purposes1. Business Investment2. Government deficit financing3. International Investment or lending

Demand for Loanable Funds

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

Loanable funds come from three places1. Private savings2. Governmental budget surpluses3. International borrowing

Supply of Loanable Funds

Supply of Loanable Funds Curve

6%

4%

40 60LF

i

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