Ro

bo

ts (t

ho

us

an

ds

)

Pizzas (thousands)

1413121110 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7 8

A B

C

D

E

W

Attainablebut

Inefficient

Unattainable

Attainable& Efficient

PRODUCTION POSSIBILITIES

Production Possibilities Curve

Shows: • Opportunity Cost: More pizzas means less

robots• Unempolyment / Inefficiency: Inside the curve• Efficiency: On the curve• Economic Growth: Curve shifts to the right

Pric

e Le

vel

Real Domestic Output, GDP

AS

AD

AGGREGATE DEMAND / AGGREGATE SUPPLY

EquilibriumReal Output

Y

P

Pric

e Le

vel

Real Domestic Output, GDPYfe

AS

AD

AS/AD: Recession

EquilibriumReal Output

ASLR

Long Run Aggregate Supply (Full Employment)

Y

P

Pric

e Le

vel

Real Domestic Output, GDP

AS

AD

AS/AD: Inflation: Beyond Full Employment

EquilibriumReal Output

ASLR

Long Run Aggregate Supply (Full Employment)

Y f Y 1

P

Pric

e Le

vel

Real Domestic Output, GDP

ASAD1

INCREASES IN AD: DEMAND-PULL INFLATION

P2

P1

AD2

Y* Y1

Pric

e Le

vel

Real Domestic Output, GDP

AS1

AD1

DECREASES IN AS: COST-PUSH INFLATION

P2

Y 1Y 2

AS2

P1

AGGREGATE SUPPLY / AGGREGATE DEMAND

SHOWS: • National Output: (Real GDP)• Employment and Unemployment• Price Level

Aggregate Demand CurveDown Sloping Due To:

• Real-Balances Effect• Interest-Rate Effect• Foreign Purchases Effect

NO

MIN

AL

inte

res

t ra

te, i

Quantity of Money

Dm

Sm

THE MONEY MARKETShift the Supply curve (always vertical) when FED changes the money supply to change nominal interest rates!

i

•If Nominal GDP Increases, Transactions Demand increases, and Dm Curve Shifts to the right.

•If Asset Demand for money increases, Dm Curve shifts to right

Real domestic output, GDP

Dm

InvestmentDemand Graph

rate

of

inte

rest

, i

10

8

6

0

Qty. of Money Amount of investment, I

MONETARY POLICY AND EQUILIBRIUM GDPSm1

AS

AD1(I=$15)

P1

10

8

6

0

Sm2

AD3(I=$25)

P2

If the Money SupplyIncreases to Stimulatethe Economy…Interest Rate DecreasesInvestment IncreasesAD & GDP Increases with slight inflation

Pri

ce le

vel

AD2(I=$20)

P3

Sm3

Increasing money supply continues the growth – but, watch Price Level.

ID

rate

of

inte

res

t, i

Money Market

Graph

Re

al I

nte

res

t R

ate

, r

Quantity of Loanable Funds

LOANABLE FUNDS MARKET

r

D

Q

S

This graph shows how the supply and demand for loanable funds affects real interest rates!

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 FINANCIAL investments

5. Increase in Foreigners’ savings

What changes Demand: 1. Increase in Household

borrowing2. Increase in business

Investment3. Increase in Foreign

borrowing4. Increase in Government

borrowing (When the gov’t has a budget deficit!) = (the crowding -out effect)

The Market for Yen

Quantity of Yen

Yen

/Dol

lar

0

e*

Qe

Sy

Dy

THE FOREIGN EXCHANGE MARKET

Dy

SyY

en/D

olla

r

Quantity of Yen

3

2

1

Dollardepreciates

Dollarappreciates

The Market for Yen

THE FOREIGN EXCHANGE MARKET

An

nu

al r

ate

of in

flat

ion

(per

cen

t)

Unemployment rate (percent)

7

6

5

4

3

2

1

0

1 2 3 4 5 6 7

As inflation declines...

THE PHILLIPS CURVE CONCEPT

unemploymentincreases

And vice versa!

SRPC

An

nu

al r

ate

of in

flat

ion

(per

cen

t)

Unemployment rate (percent)

7

6

5

4

3

2

1

0

1 2 3 4 5 6 7

THE PHILLIPS CURVE CONCEPT

SRPC 1

LRPC = Is the naturalRate of Unemployment

SRPC 2

With Stagflation, Shift SRPC to the right

With AD shift, move along existing SRPC

Phillips Curve

• Short run trade-off between inflation and unemployment.

• In the Long Run there is no trade off. The long run Phillips curve is Vertical!

• Stagflation (an increase in Unemployment and inflation) or an Aggregate Supply Shock will shift the SRPC to the right.

• Decreases in Inflation and Unemployment will shift the SRPC to the left. (and increase in AS would cause this)

TWO WAYS TO SHOW ECONOMIC GROWTH

A

B

C

D

Ca

pit

al G

oo

ds

Consumer Goods

Pri

ce

Lev

el

Real GDP

ASLR1 ASLR2

Q1 Q2

Causes of Economic Growth

1. Increased investments in Capital Stock.

2. Increased investments in Human Capital (education, training) and increases in quantity of human resources

3. New Technology leading to increased productivity

4. Increase in quantity and quality of natural resources

BUSINESSES HOUSEHOLDS

RESOURCES INPUTS

$ COSTS $ INCOMES

PRODUCTMARKET

GOODS &SERVICES

GOODS &SERVICES

$ CONSUMPTION$ REVENUE

GOVERNMENT

RESOURCEMARKET

Circular Flow Model