CH. 5 Production, Income and Employment QUIZ 1
1. Gross domestic product (GDP) is
c. the total value of all final goods and services produced for the marketplace during a given period, within a nation's borders
2. Which of the following would be counted in U.S. GDP?
b. the purchase of a new textbook
3. GDP is a flow variable because
b. it measures the production that takes place over a period of time
4. Which of the following would be counted in U.S. GDP?
a. a new U.S.-produced radio bought by a Japanese citizen living in Kyoto
5. In the expenditure approach to measuring GDP, we add the values of all
b. goods and services purchased by each type of final user
6. Which of the following describes the relationship between net investment and total investment?
a. net investment = total investment - depreciation
7. Which of the following describes the relationship between net exports and imports?
b. net exports = exports - imports
8. In order to build a table, a furniture company buys $50 worth of wood from a lumber company and $20 worth of hardware from a metal products firm. If the value added by the furniture company is $200, what price would the table sell for according to the value added approach to GDP?
e. $270
9. If output rises, then income
e. rises by an equal amount
10. Structural unemployment
a. arises from a mismatch between available jobs and workers' skills or geographic location
11. Cyclical unemployment
e. does not exist when the economy is at full employment
12. What fraction of the labor force is cyclically unemployed when structural unemployment is 2 percent, frictional unemployment is 2.5 percent, seasonal unemployment is 1 percent, and the overall unemployment rate is 8 percent?
a. 2.5 percent
13. The primary macroeconomic cost of unemployment is
c. lost output
14. If an economy has been operating below its potential output level,
d. households have experienced reductions in their standards of living
15. Which of the following people would be considered employed in the Census Bureau's Household Survey?
b. a person paid to work 2 hours per week cleaning houses
16. Mark is an 86-year-old watchmaker who works ten hours a week to supplement his retirement income. In determining the U.S. unemployment rate, Mark would be considered
a. employed
17. In an economy with 4,000 unemployed people and 8,000 employed people, the unemployment rate is
c. 33.3 percent
18. Which of the following groups would not be considered part of the labor force?
d. individuals who have given up looking for work because they have been unable to find a
job
19. Rich lost his job six months ago because of budget cuts at the county landfill where he worked. He tried finding another job, but has not actively searched for work for three months. Rich would be considered by the Bureau of Labor Statistics to be
e. a discouraged worker

CH. 5 Notes: Production Income and Employment
(GDP)
• Total value of all final goods and services produced for the marketplace during a given period within the nation’s borders
– In short-run, to alert us to recessions and give us a chance to stabilize the economy
– In long-run, to tell us whether our economy is growing fast enough to raise output per capita and our standard of living, and fast enough to generate sufficient jobs for a growing population
GDP does not include all final goods and services produced in the economy
• Includes only the ones produced for the marketplace that is, with the intention of being sold
–GDP measures output produced within
U.S. borders
• Regardless of whether it was produced by
Americans
– In order to contribute to GDP, something must be produced
GDP = C + I + G + NX

Different ways to calculate GDP
–	Value-Added Approach
–Revenue it receives for its output
• Minus cost of all the intermediate goods that it buys
• GDP is sum of values added by all
–	firms in economy
Factor Payments Approach
GDP equals sum of all firms’ value added
– Each firm’s value added is equal to its factor payments
– Total output of economy (GDP) is equal to total income earned in the economy
• GDP = Sum of factor payments made by all firms
• GDP = Wages and Salaries + interest + rent + profit
• GDP = Total household income
Expenditure approach divides output into four categories according to which group in the economy purchases it as final users
– Consumption goods and services (C)—purchased by households
– Private investment goods and services (I)—purchased
by businesses
– Government goods and services (G)—purchased by government agencies
–	Net exports (NX)—purchased by foreigners
GDP = C + I + G + NX

Real versus Nominal GDP
Usually need to adjust our measurements to reflect changes in the value of the dollar
– Nominal—when a variable is measured over time with no adjustment for the dollar’s changing value
– Real—when a variable is adjusted for the dollar’s changing value
Problems with GDP
Quality changes
• Underground economy
• Non market activity

Types of Unemployment
–	people are considered unemployed if they are not working and actively seeking a job
Frictional-
Short-term joblessness experienced by people who are between jobs or who are entering the labor market for first time or after an absence
Seasonal-
Joblessness related to changes in weather, tourist patterns, or other seasonal factors
• Is rather benign
• Unemployment insurance involved
• To prevent any misunderstandings, government usually reports the seasonally adjusted rate of unemployment
Structural-
Joblessness arising from mismatches between workers’ skills and employers’ requirements
– Generally a stubborn, long-term problem
–	Often lasting several years or more
Cyclical-
When the economy goes into a recession and total output falls, the unemployment rate rises
• Macroeconomists say we have reached full employment when cyclical unemployment is reduced to zero

COST OF UNEMPLOYMENT
Chief economic cost of unemployment is the opportunity cost of lost output
• When there is cyclical unemployment, nation produces less output
• Some groups within society must consume less output
• Potential output
– Level of output economy could produce if operating at full employment
The unemployed are those willing and able to work, but who do not have jobs
• Others were able to work, but preferred not to
• To be counted as unemployed, you must have recently searched for work
Unemployment rate= Unemployed / (employed +unemployed)

CH. 6, 7, 8…..QUIZ 2
1. In any monetary system, the means of payment must be the same as the unit of value.
b. False
2. If the government passed a law designating sea shells as money, sea shells
e. would function as money as long as they were accepted in exchange for goods and services
3. If a piece of currency must be accepted for payment because the government says so, the currency is called
a. commodity money
4. An index number is important only in a relative sense -- in comparison to an index number from another period.
a. True
5. The Consumer Price Index (CPI)
e. includes the prices of some used consumer goods
6. The real wage can increase only if the nominal wage increases.
b. False
7. In which of the following situations would a worker be happiest?
a. She receives a pay cut and her nominal wage falls by 5 percent, while the CPI falls by 20 percent.
8. Use the table below to find the real wage in 2003.
Year Nominal Wage ($/hour) CPI
2002 $12.50 155.0
2003 $13.00 160.0
b. $8.13
9. The wage rate that workers should really care about is
e. the real wage rate
10. Parvez is trying to decide whether or not he should lend $1,000 to Eli for a year. Eli would pay a fixed nominal interest rate of 8 percent. Parvez expects the inflation rate to be 4 percent for the year. If he does not lend the $1,000 to Eli, Parvez will purchase an indexed savings bond that pays an interest rate of 4 percent, or he will put the money in a (nonindexed) savings account earning 6 percent. Parvez
c. is indifferent between lending the money to Eli and buying the bond because the real
interest rate is the same in either case
11. Which of the following statements about unanticipated inflation is true?
c. It redistributes purchasing power in the economy.
12. Suppose the nominal interest rate charged is 5 percent and the expected inflation rate is 2 percent. Which of the following is the expected real interest rate?
e. 3 percent
13. If a lender wants a real return of 6 percent and she expects inflation to be 4 percent, which of the following is the correct nominal interest rate to charge?
d. 10 percent
14. Inflation will general redistribute purchasing power when
b. it is completely unexpected
15. Inflation
a. hurts society by imposing additional opportunity costs
16. Factors that cause the CPI to exaggerate the inflation rate do not include
b. political pressure from unions and retirees on the Bureau of Labor Statistics to overstate the inflation rate (substitutes, quality, technology)
17. A critical assumption in the classical model is that
b. markets clear in the long run
18. If the actual real wage exceeds the equilibrium wage, there will be an excess supply of labor.
a. True
19. An excess demand for labor will cause the wage rate to rise to its equilibrium level immediately.
b. False
21. The labor demand curve slopes downward because
a. firms wish to hire fewer workers as the wage rate increases
22. In a labor market diagram, the point at which the labor supply curve crosses the labor demand curve is
c. the point at which everyone who wants to work is able to find a job
23. Refer to Figure 7-2. The economy's potential level of output on the graph
e. equals $8 trillion
24. Say's Law states that by purchasing goods and services, buyers stimulate firms to produce goods and services equal to what has been purchased: Demand creates its own supply.
b. False
 25. Say's Law is the idea that
d. whenever a good or service is produced, an equal amount of income is created
26. Total spending will equal total output
b. only when total leakages are equal to total injections
27. What is the relationship between the government's budget deficit and its tax revenue?
b. budget deficit = government spending - tax revenue
28. Changes in government spending or taxes designed to stimulate the economy are examples of
a. fiscal policy
29. In the classical model, if government tries to increase employment and output by increasing its own purchases,
c. its actions will cause the interest rate to rise, which will choke off investment spending
Chapter 6:The Monetary System, Prices, and Inflation
Monetary System
• Establishes two different types of standardization in the economy
– Unit of value
– Means of payment
• In United States, the dollar is centerpiece of monetary system
While government can declare that paper currency is to be accepted as a means of payment, it cannot declare the terms
CPI is a measure of the price level in the economy
– Inflation rate measures how fast price level is changing, as a percentage rate
– When price level is rising, as it almost always is, inflation rate is positive
– When price level is falling, we have a negative inflation rate
• Called deflation
Used in three major ways
– As a policy target
– To index payments
–	To translate from nominal to real values
Several reasons for upward bias in CPI
– Substitution bias
– New technologies
– Changes in quality
CPI AND GDP
• Can summarize chief difference between CPI and
GDP price index
– GDP price index measures prices of all goods and services that are included in U.S. GDP
– While CPI measures prices of all goods and services bought by U.S. households
Inflation
When price level is rising, as it almost always is, inflation rate is positive
– When price level is falling, as it did during Great
Depression, we have a negative inflation rate
• Called deflation
• Inflation can redistribute purchasing power from one group to another
– But it does not directly decrease average real income
Over any period, percentage change in a real value (%Δ Real) is approximately equal to percentage change in associated nominal value
(%Δ Nominal) minus the rate of inflation
–	%ΔReal -%ΔNominal = Rate of Inflation
Expected Inflation
Over any period, percentage change in a real value (%Δ Real) is approximately equal to percentage change in associated nominal value
(%Δ Nominal) minus the rate of inflation
– %ΔReal = %ΔNominal – Rate of Inflation
• If inflation is fully anticipated, and if both parties take it into account, then inflation will not redistribute purchasing power
• When inflation is not correctly anticipated, however, our conclusion is very different
• Nominal interest rate
– Annual percent increase in a lender’s dollars from making a loan
• Real interest rate
– Annual percent increase in a lender’s purchasing power from making a loan
• In absence of inflation, real and nominal interest rates would always be equal
Unexpected Inflation
When inflationary expectations are inaccurate:
– Purchasing power is shifted between those obliged to make future payments and those waiting to be paid
– An inflation rate higher than expected harms those awaiting payment and benefits the payers
– An inflation rate lower than expected harms the payers and benefits those awaiting payment
BIASES in the Calculation of CPI Several reasons for upward bias in CPI
– Substitution bias
– New technologies
– Changes in quality
Real wage formula is as follows
Nominal wage in that year/CPI in that year x 100
Real Value formula
Nominal value/price index x 100
An index number:
Value of measure in base period/ Value of measure in current period x 100ssical Long-Run
Chapter 7: The Classical Long Run Model
Classical Model
–	Long run comes quick
–	Supply matters, holds key
–	All markets clear(price adjust so demand=supply)
–	output=potential output
–	Both agree output=potential output
–	Fiscal/monetary are ineffective
–	Classical model has proven more useful in explaining the long-run trend itself
–	Achieves full employment on it’s own
–	Reaches potential output automatically
–	Government not worried bout total spending/employment
Keynesian Model
–	Long run may not come
–	Demand matters
–	Markets don’t clear
–	Output <potential output
–	Fiscal/monetary may be effective
 Says Law
•	Total spending must be equal to total output
•	by producing goods and services
– Firms create a total demand for goods and services equal to what they have produced or
• Supply creates its own demand
Labor Market
Labor supply curve slopes upward
– Because—as wage rate increases—more and more individuals are better off working than not working
– Thus, a rise in wage rate increases number of people who want to work—to supply their labor
When all firms behave this way together a rise in wage rate will decrease quantity of labor demanded

Production Function between total employment and total production in the economy
– Given by economy’s aggregate production function
• Shows total output economy can produce with different quantities of labor
– Given constant amounts of other resources and current state of technology
Net Taxes
= total tax revenue – transfers
Planned Investment spending
Total investment spending- change in inventories
Total Spending
= C + IP + G
Leakages and Injections
Saving and net taxes are called leakages out of spending
– Amount of income that households receive, but do not spend
• There are also injections—spending from sources other than households
– A government’s purchases of goods and services
– Planned investment spending (IP)
• Total spending will equal total output if and only if total leakages in the economy are equal to total injections
– Only if sum of saving and net taxes is equal to sum of planned investment spending and government purchases
Fiscal Policy and Classical Model
Fiscal policy is a change in government purchases or in net taxes
–	Designed to change total spending in the economy and thereby influence levels of employment and output
With Budget Deficit- In classical model a rise in government purchases completely crowds out private sector spending so total spending remains unchanged
• In classical model, an increase in government purchases has no impact on total spending and no impact on total output or total employment
Fraction of population working (LFPR)
• LFPR = Labor Force ÷ Population
• A cut in tax rates increases reward for working
– While a cut in benefits to the needy increases hardship of not working
– Either policy can cause a greater rightward shift in the economy’s labor supply curve than would otherwise occur and create growth in labor force participation and output
• Government policies can also affect labor demand curve
– Government policies that help increase skills of the workforce or that subsidize employment more directly shift the economy’s labor demand curve to the right
• Increasing employment and output
Average Hours= Total hours worked ÷ Labor Force

Chapter 8: Economic growth and rising living standards
–	What matters for a rising standard of living is real GDP per capita
–	Developed countries, average hours are slowly decreasing
How to Increase employment and LFPR
Focuses on changing labor supply
– An often-proposed example of this type of policy is a decrease in income tax rates
–	A cut in tax rates increases reward for working
Drawbacks of Increasing LFPR
LFPR cannot create rapid growth in living standards indefinitely, because there is a logical upper limit of 100%
–	In developed economies, raising LFPR means that people who currently do not want jobs must change their minds and want to work
Capital Stock and Productivity
– Amount of capital available for average worker
– With more capital a given number of workers can produce more output than before
If capital stock grows faster than labor force then capital per worker will rise
• Labor productivity will increase along with it
– But if capital stock grows more slowly than labor force, then capital per worker will fall
• Labor productivity will fall as well
Contributes to a rise in labor productivity and helps to raise living standards
Incentive to Invest
A decrease in government purchases results in Raising consumption and investment
Corporate profits tax
– Tax on profits earned by corporations
• Investment tax credit
– A reduction in taxes for firms that invest in certain favored types of capital
• Reducing business taxes or providing specific investment incentives can shift the investment curve rightward

Incentive to Save
If any of these occur: shifts saving curve to right
–	Greater uncertainty about economic future
– Increase in life expectancy
– Anticipation of an earlier retirement
– Change in tastes toward big-ticket items
–	Change in attitude about saving
Government and savings
–	decrease capital gains tax
Another frequently proposed measure is to switch from current U.S. income tax
• Another proposal to increase household saving is to restructure U.S. Social Security system
• Government can alter tax and transfer system to increase incentives for saving
Relationship


CH 10 The Short- Run Macro Model QUIZ 3:
1. If labor supply increases, the wage rate increases.
b. False
2. Refer to Figure 8-1. If labor supply shifts from S1 to S2, what will happen to the real hourly wage rate?
b. It will fall to $15 and employment will increase to 120 million
3. Growth in employment can result
d. from an increase in either labor supply or labor demand
4. If the labor demand decreases, what will happen to the real wage, employment, and output, assuming no change in the labor supply?
e. The real wage will decrease, employment will decrease, and real output will decrease.
5. Which of the following best describes what has happened to the U.S. labor supply and labor demand over the past 50 years?
d. Both labor supply and labor demand increased.
6. Government policies designed to increase the skills of the work force shift the labor demand curve to the right, increasing employment and total output.
a. True
7. What would be the effect of a reduction in the corporate profits tax?
c. Investment would increase, the production function would shift upward, and both
productivity and output would increase.
9. If we know that the slope of the consumption function is 0.6, then we know that if real disposable income increased by $1,000 billion, real consumption spending would
c. increase by $600 billion
10. If real consumption spending increases by $400 billion each time real disposable income rises by $1,000 billion, the marginal propensity to consume is
c. 0.4
11. Which of the following is not another way of describing the marginal propensity to consume?
a. MPC
b. the slope of the consumption function
c. the change in real consumption spending divided by the change in real disposable income
d. the amount by which real consumption spending rises when real disposable income
increases by one dollar
e. autonomous consumption spending
12. Refer to Figure 10-3. Which of the following could explain upward shift from C1 to C2?
e. a decrease in net taxes that increases autonomous consumption spending
13. If Americans became more negative about the economy, what would happen to the consumption-income line?
d. the entire line would shift downward
14. If income increased by $20,000, government purchases are fixed at $10,000, investment spending is fixed at $5,000, net exports are fixed at $500, and aggregate expenditure increases by $15,000, what is the marginal propensity to consume (MPC)?
b. 0.75
15. Which of the following is an equilibrium condition of the short-run macro model?
c. Aggregate expenditure equals output.
16. If aggregate expenditure at a particular level of income is less than output,
b. output will decrease
17. In the short-run macro model, if firms produce more output than they sell, those firms will
b. decrease their output
18. In the short-run macro model, if the economy is in equilibrium, it must also be operating at full employment.
b. False
20. Refer to Figure 10-9. If YFE represents the full employment level of output, the situation depicted at Y1 in the graph is
d. identified as an expansion
21. In the short-run macro model, which of the following is the cause of cyclical unemployment?
b. Insufficient aggregate spending.
22. If firms increase their investment spending, the resulting change in equilibrium GDP is equal to the change in investment spending
c. multiplied by the expenditure multiplier
23. If the expenditure multiplier is 3.5 and investment spending increases by $2,000 billion, what will be the change in GDP?
e. $7,000 billion
24. If the marginal propensity to consume is 0.7, the expenditure multiplier is
d. 3.3
25. A spending shock is a change in spending that ultimately affects the entire economy.
a. True
26. The expenditure multiplier acts on changes in investment spending, government purchases, net exports, and autonomous consumption.
a. True
27. The impact of saving on the economy is
d. beneficial in the long run, but not necessarily in the short run
28. Fiscal policy
b. can change equilibrium GDP in the short run, but not long run.

CH 10: The Short-Run Macro Model
-Basic Features of Keynesian Model
•	Short-run macro model focuses on spending in explaining economic
Fluctuations
•	Causing changes in total output and employment
•	Demand for output creates output
•	Focus on spending
•	Disposable income= income-net taxes
•	Three key variables: Disposable income, wealth, IR
•	CS up when DI up, Wealth up when IR down
•	MPC= Change in C/ change in DI
Consumption Function and Consumption Income line
-	CI affected by taxes but not income
-	CI LINE/ Auto UP WHEN: Taxes down, wealth up, interest rate down, and optimism
-	CI LINE MOVES LEFT: Income down
-	Relationship between consumption and disposable income is almost perfectly linear
-	Slope/ MPC = Δ Consumption ÷ Disposable Income (always >0)
-	Consumption  Function – C = auto + Slope or MPC x (Disposable Income)
-	CI- When a change in anything else besides income causes consumption spending to change, the line will shift, All changes that shift the line—other than a change in taxes—work by increasing or decreasing autonomous consumption (a)
Investment Spending
“I” consists of three components
– Business spending on plant and equipment
– Purchases of new homes
– Accumulation of unsold inventories
Net exports
Total Exports- total imports
Aggregate Expenditure
C+Ip+G+NX
-	When income increases, aggregate expenditure (AE) will rise by
MPC times change in income
• ΔAE= MPC x Δ GDP
-	When aggregate expenditure is less than GDP, output will decline in future (Vice versa)
-	AE < GDP 􀃎 ΔInventories > 0 􀃎 GDP↓ in future periods
-	AE > GDP 􀃎 ΔInventories < 0 􀃎 GDP↑ in future periods
-	AE = GDP 􀃎 ΔInventories = 0 􀃎 No change in GDP
EXPENDITURE MULTIPLIER
-	ΔGDP = 2.5 x ΔIP
-	Formula= 1/(1-MPC)

CH 11 Banking System/ Money Supply Quiz 4
1. Which of the following is the most liquid form of asset?
e. travelers' checks
2. When economists and government officials speak about the money supply, they usually mean M2.
b. False
3. Which of the following is not included in the M1 money stock? Others included
a. small time deposits
b. demand deposits
c. checking account deposits
d. travelers' checks
e. cash in the hands of the public
4. If the required reserve ratio is 0.2, and a bank has $100 million in demand deposits and $40 million in property and buildings, it must hold reserves of at least
b. $20 million
5. Which of the following groups exerts the most control over the money supply in the United States?
d. the Federal Reserve
7. An important function of the Federal Reserve is
a. clearing checks
8. The formula for the demand deposit multiplier is
b. 1.0 divided by the required reserve ratio
9. If the required reserve ratio is 0.2, the demand deposit multiplier is
d. 5
10. When banks create money, they
e. do not create wealth
11. If the required reserve ratio (RRR) is 10 percent and the Fed sells a $10,000 bond directly to First National City Bank, the immediate change in the money supply will be
a. no change
12. If the required reserve ratio is 20 percent, banks loan out all excess reserves, people hold no currency, and the Fed sells $5,000 worth of bonds to banks, what is the ultimate impact on the money supply?
d. The money supply will decrease by $25,000.
13. Examples of Fed actions that could decrease money supply are making open market
d. sales, increasing the required reserve ratio, and increasing the discount rate
14. Which of the following would lead to a decrease in the money supply?
d. The Fed sells government bonds.
15. A bank can only fail if it is not in good financial health.
b. False
16. Congress created the FDIC to:
E. reimburse those who lose their bank deposits

CH 11: The Banking System and The Money Supply
Most Liquid to Least
1-	cash in hand of public
2-	Travelers Checks, demand deposits, checkable deposits
3-	Savings Accounts
4-	MMMF
5-	Small time deposits
6-	Large time deposits
M1 AND M2
M1 = cash in the hands of the public + demand deposits + other checking account deposits + travelers checks
M2 = M1 + savings-type accounts + retail MMMF balances + small denomination time deposits

Role of Federal Reserve
Federal Reserve, as overseer of the nation’s monetary system, has a variety of important responsibilities including
– Supervising and regulating banks
– Acting as a “bank for banks”
– Issuing paper currency
– Check clearing
–	Controlling money supply
THREE WAYS FED CHANGES MONEY SUPPLY
–	Reduce RRR ( banks can lend more)
–	Changes discount rate- lower = MS UP
–	Open market operations
HOW FED INCREASES MONEY SUPPLY
To increase money supply, Fed will buy government
bonds
– Called an open market purchase
• Suppose Fed buys $1,000 bond from Lehman Brothers,
which deposits the total into its checking account
– Two important things have happened
• Fed has injected reserve into banking system
• Money supply has increased
– Demand deposits have increased by $1,000 and demand deposits are
part of money supply
– Lehman Brothers’ bank now has excess reserves
FOMC
Committee exerts control over nation’s money supply by buying and selling bonds in public (“open”) bond market

Demand Deposit Multiplier
Whatever the injection of reserves, demand deposits will increase by a factor of 10, so we can write
–	ΔDD = 10 x reserve injection (how to find increase in DDM)
Change in MS= DDM x Federal purchase of bonds
DDM=  1/RRR
What happens when they inject money-
–	ΔDD = (1 / RRR) x ΔReserves

BONDS
Two components: Face value and Maturity
Types of bonds: Perpetuity, zero coupon bond, Coupon bond (most common)

CHAPTER 12  Money Market/ Interest Rate QUIZ 5
1. The demand for money
d. reflects the constraints that people face
2. An increase in the interest rate reduces the opportunity cost of holding money.
b. False
3. An individual's quantity of money demanded
d. refers to the amount of her wealth that an individual chooses to hold in the form of
money
4. Which of the following determines how much money an individual will decide to hold?
c. the supply of money
5. Which of the following would be most likely to increase the quantity of money demanded?
a. an increase in the price level
6. Which of the following would be most likely to increase the quantity of money demanded (i.e., to cause a movement along the money demand curve)?
c. a decrease in the interest rate
7. If income changes, that leads to a movement along the money demand curve.
b. False
8. Refer to Figure 12-1. If the economy is currently at point X, an increase in the interest rate will
b. decrease the quantity of money demanded (moving the economy toward point B)
9. The economy's money supply curve is vertical because the Fed constantly changes the money supply.
b. False
10. The money supply is
e. set by the Fed and therefore independent of the interest rate and income
11. Open market sales of bonds by the Federal Reserve drain reserves from the banking system and shift
c. the money supply curve leftward
12. The equilibrium short-run interest rate is determined at the intersection of the demand and supply curves in the market for
b. money
13. Equilibrium in the money market means that the quantity of money people are holding equals
c. the quantity of money that they want to hold
14. An excess demand for money exists if the interest rate is below the equilibrium rate.
a. True
15. An effective way to explain the process of how the money market reaches equilibrium is to begin with an interest rate that is
a. not the equilibrium value and watch the forces that move it toward equilibrium
16. If the interest rate is above its equilibrium value, the price of
c. bonds will rise
17. If Chris pays $500 for a bond that will return $750 in one year, what is the interest rate?
a. 50 percent
18. The higher the price of a bond in the secondary market, the
e. lower the interest rate must be
19. If the Fed wishes to raise the interest rate, it will
b. decrease the money supply
20. If the Fed decreases the money supply, we should expect the interest rate
b. to rise, spending on automobiles and business investment spending to fall, and the price
of bonds to decrease
21. In the short-run macro model, an open-market purchase of bonds by the Fed will
e. lower the interest rate, increase spending, and increase output
22. If the Fed conducts open market purchases, we should expect to see the money supply
c. increase, the interest rate decrease, autonomous consumption increase, businessinvestment increase, and real GDP increase
23. If the interest rate increases due to an increase in government purchases, the rise in real GDP will be greater than what would have occurred if the interest rate had remained stable.
b. False
24. An increase in government spending leads to a(n)
b. upward shift of the aggregate expenditure line and a rightward shift of the money demand curve
25. Which of the following dampens the effect on GDP of a change in government spending?
c. Money demand changes when real income changes.
26. In the short run, following an increase in government purchases,
d. the interest rate rises because the money demand curve shifts rightward
27. What will be the effects of a decrease in government spending?
d. a decrease in equilibrium GDP, a decrease in money demand, a decrease in the interest rate, and an increase in investment spending
28. If the federal government announces a tax cut, which of the following is most likely in the short run?
e. an increase in output, an increase in money demand, and an increase in the interest rate
29. On a short-run macro model diagram, the impact of a decrease in government purchases (G) is illustrated by
d. a downward shift of the aggregate expenditure line by an amount less than the change in
30. When the public as a whole expects an increase in the interest rate, their resulting actions will
d. drive up the interest rate now
31. Which of the following will increase money demand only?
e. an expectation by the public of a higher interest rate in the future

CHAPTER 12: The Money Market and the Interest Rate
Demand for money
Rather, it means how much money people would like to hold,given constraints they face
What determines how much money an individual will decide to hold?
• Price level
• Real income
• Interest rate
Demand for money depends on the same three variables that we discussed for individuals
– A rise in the price level »» increased demand for money
– A rise in real income (real GDP) »» increased demand for money
–	A rise in interest rate »» decreased demand for money
Shifts in Money demand curve
What happens when something other than interest rate changes quantity of money demanded?
– Curve shifts
• A change in interest rate moves us along money demand curve
IR UP- MOVES Left along MD curve Vice versa
Open market purchases of bonds inject reserves into banking system
– Shift money supply curve rightward by a multiple of reserve injection
– Open market sales have the opposite effect
• Withdraw reserves from system
– Shift money supply curve leftward by a multiple of reserve withdrawal
Money demand curve tells us how much money people want to hold at each interest rate
-	at a lower interest rate there is an excess demand for money and causes  IR rises
-	At a higher IR, excess supply of money causes IR to fall
PROCESSES
IR HIGHER than E>>Excess MS & Excess Bond Demand>>Bond Price Up>>Interest Rate Down

If Fed increases money supply by buying government bonds, the interest rate falls

INTEREST RATE
Fed officials cannot just declare that interest rate should be lower
• Fed must change the equilibrium interest rate in the money market
• Does this by changing money supply
-	Lower interest rate stimulates business spending on plant and equipment
-	Interest rate changes also affect spending on new houses and apartments that are built by developers or individuals
-	When Fed increases money supply, interest rate falls, and spending on three categories of goods increases
• Plant and equipment
• New housing
• Consumer durables (especially automobiles)
– When Fed decreases money supply, interest rate rises, and these categories of spending fall
OPEN MARKET PURCHASE>>MS UP>>IR DOWN>>G AND P UP>>MULTIPLIER EFFECT>>REAL GDP UP

AN INCREASE IN GOVERNMENT PURCHASES
At the same time as the increase in government purchases has a positive multiplier effect on GDP
– Decrease in a and I have negative multiplier effects
• In short-run, increase in government purchases causes real
GDP to rise
– But not by as much as if interest rate had not increased
– Aggregate expenditure line is higher, but by less than ΔG
– Real GDP and real income are higher
• But rise is less than [1/(1 – MPC)] x ΔG
– Money demand curve has shifted rightward
• Because real income is higher
– Interest rate is higher
• Because money demand has increased
– Autonomous consumption and investment spending are lower
• Because the interest rate is higher
An increase in government purchases raises interest rate and
An increase in government purchases raises interest rate and crowds out some private investment spending
– May also crowd out consumption spending
• In classical, long-run model, an increase in government purchases also causes crowding out
• In short-run, however, conclusion is somewhat different
– While we expect some crowding out from an increase in government purchases, it is not complete
– Investment spending falls, and consumption spending may fall, but together, they do not drop by as much as rise in government purchases
–	In short-run, real GDP rises

SPENDING SHOCKS
Positive shocks would shift aggregate expenditure line upward
• Increases in government purchases, investment, net exports, and autonomous consumption, as well as decreases in taxes, all shift aggregate expenditure line upward
– Real GDP rises, but so does interest rate
– Rise in equilibrium GDP is smaller than if interest rate remained constant
• Negative shocks shift aggregate expenditure line downward
• Decreases in government purchases, investment, net exports, and autonomous consumption, as well as increases in taxes, all shift aggregate expenditure line downward
– Real GDP falls, but so does interest rate
– Decline in equilibrium GDP is smaller than if interest rate remained constant

EXPECTATIONS AND THE MONEY MARKET
A general expectation that interest rates will rise (bond prices will fall) in the future
– Will cause money demand curve to shift rightward in the present
• When public as a whole expects interest rate to rise (fall) in the future, they will drive up (down) interest rate in the present




CH 13 Aggregate Demand/Supply QUIZ 6
1. Refer to Figure 13-1. Assume the economy is in equilibrium at $7 trillion. If the changes in all three graphs were caused by the same event, what was that event?
b. an increase in the price level
2. In the aggregate demand-aggregate supply model, an increase in the price level will
a. increase money demand, raise the interest rate, reduce aggregate expenditure, and decrease equilibrium real GDP
3. A decrease in the price level leads to which of the following sequences?
a. The money demand curve shifts leftward, the interest rate drops, the aggregate
expenditure line shifts upward, and there is movement downward along the aggregate
demand curve.
4. The AD curve is derived by adding up demand curves for all goods and services.
b. False
5. Which of the following will cause a movement along the aggregate demand curve?
a. a decrease in the price level
6. A downward movement along the AD curve is caused by
c. a decreasing price level
7. If the money demand curve shifts rightward, the AD curve also shifts rightward.
b. False
8. A spending shock
e. causes equilibrium GDP to change at each price level
9. If autonomous consumption decreases, which of the following combinations of events would be most likely to occur?
b. a downward shift of the aggregate expenditure line, a leftward shift of the money demand curve, and a leftward shift of the aggregate demand curve
10. If the government announces a big tax cut, which of the following combinations of events would be most likely to occur?
a. an upward shift of the aggregate expenditure line, a rightward shift of the money demand
curve, and a rightward shift of the aggregate demand curve
11. Wages often respond slowly to changes in output.
a. True
12. The equilibrium price level
c. is influenced by the pricing behavior of all the firms in the economy
13. A short-run decrease in real GDP will
c. decrease the price of non-labor inputs, decrease input requirements per unit of output, and
decrease the price level
14. The aggregate supply curve would shift downward if
c. good weather increases crop yields
15. Refer to Figure 13-5. Assuming that the economy starts at point X, a decrease in world oil prices would
d. shift the aggregate supply curve downward to curve D
16. If a war interrupted oil production, which of the following would most likely happen in the short run?
b. Unit costs would increase and the aggregate supply curve would shift upward.
17. The intersection of the AD and AS curves
d. is the short-run macroeconomic equilibrium point
18. Refer to Figure 13-7. If the economy is currently at a price level of 120 and real GDP is $6.5 trillion, an increase in government purchases will, in the short run,
a. shift the aggregate demand curve rightward, increasing both the price level and real GDP
19. In the short run, an increase in the money supply will
d. result in decreases in the interest rate and increases in real GDP, which are then followed
by increases in the interest rate which offset some of the increase in real GDP
20. If government spending decreases, which of the following would occur?
c. a decrease in GDP, a decrease in the price level, a decrease in money demand, and a decrease in the interest rate
21. If the government decreases taxes, which of the following would occur?
a. an increase in GDP, an increase in the price level, an increase in money demand, and an
increase in the interest rate
22. A positive demand shock may
a. cause an economy to operate at a point above potential GDP in the short run
23. In the long run, unusually high unemployment
b. forces the wage rate down
24. With the self-correcting mechanism, if a negative demand shock occurs,
a. a decrease in wage rates will lead to a decrease in the price level so that the economy
returns to full employment
25. In the long run, changes in equilibrium GDP are most likely to be caused by
a. changes in full-employment output
26. The vertical aggregate supply curve is consistent with
a. the classical model
27. The long-run aggregate supply curve
a. is vertical
28. An increase in oil prices is considered a supply shock because it would lead to a shift of the aggregate supply curve.
a. True
29. If the price level is increasing and output is falling, which of the following could be the reason?
d. a negative supply shock
30. Stagflation is the combination of
d. falling output and falling unemployment
Chapter 13 Notes: Aggregate Demand, Aggregate Supply
The Aggregate Demand Curve
–Tells us equilibrium real GDP at any price level
•	When price level rises, money demand curve shifts rightward
– Money demand curve has shifted rightward
– Interest rate is higher
– Aggregate expenditure line has shifted downward
–	Equilibrium GDP is lower
Each point on curve represents a short-run equilibrium in economy
• A better name for AD curve would be “equilibrium output at each price level”
Movements Along the AD Curve
 Moving Left>>Price level up > MD increase > Higher IR> G and P decrease>>>E GDP Down
Shifts of the Aggregate Demand Curve
When a change in price level causes equilibrium GDP to change, we move along AD curve
• Whenever anything other than price level causes equilibrium GDP to change,
AD curve itself shifts
• Equilibrium GDP will change whenever there is a change in any of the following : Government purchases, Taxes, Autonomous consumption spending, Investment spending, Net exports, Money supply
An Increase in Government Purchases
• Spending shocks initially affect economy by shifting aggregate expenditure line
• An increase in government purchases shifts entire
AD curve rightward
• AD curve shifts rightward when government purchases, investment spending, autonomous consumption spending, or net exports increase, or when taxes decrease
Changes in the Money Supply and the Aggregate Demand Curve
• Changes in money supply will also shift aggregate demand curve
– Imagine that Fed conducts open market operations to increase money supply
– AD curve shifts rightward
Effects of Key Changes on the Aggregate Demand Curve
Entire AD curve shifts rightward if:
• a, IP, G, or NX increases
• Net taxes decrease
• The money supply increases
GDP, Costs, and the Price Level
-A firm sets price of its products as a markup over cost per unit
-Percentage markup in any particular industry will depend on degree of competition there
-In short-run, price level rises when there is an economy-wide increase in unit costs.
Nominal wage rate is fixed in short-run
– In short-run, a (fall) in real GDP, by causing unit costs to (decrease), will also cause a (decrease) in price level
As total output increases..
• Greater amounts of inputs may be needed to produce a unit of output
• Price of non-labor inputs rise
• Nominal wage rate rises
The Aggregate Supply Curve
Each time we change level of output, there will be a new price level in short-run
– Giving us another point on the figure
– If we connect all of these points, we obtain economy’s aggregate supply curve
• Tells us price level consistent with firms’ unit costs and their percentage markup at any level of output over short-run.
Graph
Starting at point E, an increase in output raises unit costs. Firms raise prices, and the  overall price level rises.

Movements Along the AS Curve
When a change in output causes price level to change, we move along economy’s AS curve
When Real GDP INCREASES>> Input requirements per unit of output Increase>>prices of nonlabor inputs INCREASE>>Unit costs INCREASE>> Price level INCREASE
Shifts of the AS Curve
When a change in real GDP causes the price level to change, we move along AS curve
• When anything other than a change in real GDP causes price level to change, AS curve itself shifts
• What can cause unit costs to change at any given level of output?
– Changes in world oil prices
– Changes in the weather
– Technological change
– Nominal wage, etc.
UPWARD SHIFT
When unit costs rise at any given real GDP, the AS curve shifts upward–e.g., an increase in world oil prices or bad weather for farm production.((any reason besides an increase in real GDP))
AD and AS Together: Short-Run Equilibrium
Where is our short-run macroeconomic equilibrium?
• Only when economy is at point E—on both curves—will we have reached a sustainable level of real GDP and the price level
Demand/Supply Shocks and the Aggregate Curves
Our short-run equilibrium will change when either ADcurve, AS curve, or both, shift
– An event that causes AD curve to shift is called a demand shock
– An event that causes AS curve to shift is called a supply shock
– Demand shocks and supply shocks are just two different categories of spending shocks
 Increase in Government Purchases and AD/AS
• Shifts AD curve rightward
– Assumes that when government purchases rise, first output increases, and then price level rises
– In reality, output and price level tend to rise together
Other Demand Shocks
• A positive demand shock—shifts AD curve rightward
– Increases both real GDP and price level in short-run
• A negative demand shock—shifts AD curve leftward
– Decreases both real GDP and price level in short-run
Short-Run Effects of Supply Shocks
– An increase in world oil prices that shifts aggregate supply curve upward, from AS1 and AS2
– Called negative supply shock, because of negative effect on output
• In short-run a negative supply shock shifts AS curve upward, decreasing output and increasing price level
– Economists and journalists have coined term “stagflation” to describe a stagnating economy experiencing inflation
• A negative supply shock causes stagflation in short-run
• Examples of positive supply shocks include unusually good weather, a drop in oil prices, and a technological change that lowers unit costs
–a positive supply shock can sometimes be caused by government policy
Long-Run Effects of Supply Shocks
• In other cases, however, a supply shock can last for an extended period
• In long-run, economy self-corrects after a supply shock, just as it does after a demand shock
– When output differs from its full-employment level
• Wage rate changes
• AS curve shifts until full employment is restored