The Aggregate Expenditures Model: Slope of aggregate expenditures schedule will increase as a result of increase in MPC.

. When AE = GDP, planned I = S If AE > GDP in a private closed economy, planned I > S. Unintended increase in business inventories is when GDP > equilibrium. At equilibrium GDP for private open economy, net exports may be + or -. Increase in taxes of specific amount will have smaller impact on equilibrium GDP than decline in government spending of same amount because some of the tax increase will be paid out of income that would otherwise have been saved; for decreases in taxes, part of tax cut will be saved. Change in consumption from lump-sum tax = C (LS Tax x MPC). Recessionary Gap = MPC x Difference between Equilibrium GDP and Full-Emp. GDP.

Aggregate Demand and Aggregate Supply: AS curve steeper above full-employment than below because per-unit production costs rise as output increases. Input price change does not change productivity. Reduction in personal and business taxes AD and AS. Size of multiplier diminishes if inflation occurs. Prices and input costs usually flexible upward but not downward. Wage contracts, price wars, minimum-wage law.

Fiscal Policy, Deficits, and Debt: Built-in stability means that with given tax rates and expenditures policies, a rise in domestic income will reduce a budget deficit or produce a budget surplus while a decline in income will result in a deficit or a lower budget surplus. Personal and corporate income tax collections automatically rise and transfers and subsidies automatically decline as GDP rises. Tax revenues vary directly with GDP, but government spending is independent of GDP. The cyclically-adjusted budget is less likely to show deficit than actual budget. Expansionary fiscal policy will increase cyclically-adjusted deficit but reduce actual deficit. Money, Banking, and Financial Institutions: Currency in bank vaults not part of money supply. Purchasing power of money and price level vary inversely. If price index rises from 200 to 250, purchasing power value of dollar will fall by 20%. The basic policy-making body in the U.S. banking system is the Board of Governors of the Fed. Basic function of Fed = control money supply Money Creation: Main purpose of reserve ratio is to influence lending abilities of banks. In prosperous times banks likely to hold small amnts of excess reserves because Fed pays lower interest rates on bank reserves.

Interest Rates and Monetary Policy: Interest rates and bond prices inversely related. Asset demand for money downsloping because opportunity cost of holding money increases as interest rate increases; transactions demand vertical line. Fed selling securities to commercial banks does not directly affect money supply, but does decrease the banks money-creating potential. Discount rate: interest rate on loan given by Fed to commercial banks. Monetary policy affects investment the most. Causes shifts in AD curve. Extending the Analysis of Aggregate Supply: LRAS vertical because input prices fluctuate to match product prices in long run. Stabilization in cost-push inflation causes inflationary spiral. Actual inflation < expected inflation = unemployment rate temporarily rise. Actual inflation > expected inflation = increased profits and employment. International Trade: Land-int. commodity: wool. Capital: chemicals. Labor: cameras. Increasing opportunity costs limit specialization. Tariff brings revenue for U.S. Treasury.

The Balance of Payments, Exchange Rates, and Trade Deficits: Outflow e.g., U.S. asset purchases abroad. Inflow e.g., foreign purchases of U.S. assets. Current account surplus means capital and financial account deficit if no official reserve payments. Balance of payments is total of international financial transactions and payments and is always in balance. Diminishing official reserves of foreign currencies signifies chronic balance-of-payments deficit. Nations consumers helped by trade deficit. Balance if trade: imports of goods and services, exports of goods and services. Increase in dollar price of yen = dollar depreciation Depreciation of dollar = increased price of U.S. imports, decreased price of U.S. exports. Pound demand downsloping because lower dollar price of pounds = British goods cheaper to U.S. and U.S. will buy more of their goods and services. Supply of pound upsloping because higher dollar price of pounds = U.S. goods cheaper to the Britain. With fixed exchange rates, when price of currency is above equilibrium, there will be a surplus of that currency. With flexible exchange rates, increase in currency value causes that countrys imports to increase. Reduce currency value by selling it in foreign exchange market. Large trade deficit =increased current consumption and increased indebtedness to foreigners. Speculators helpful by taking exchange rate risk. Determinants of Aggregate Demand Determinants of Aggregate Supply 1. Change in consumer spending 1. Change in input prices a. Consumer wealth b. Consumer expectations c. Household borrowing a. Domestic resource prices d. Taxes 2. Change in investment spending b. Prices of imported resources a. Interest rates b. Expected returns Expected future business conditions 2. Change in productivity Technology Degree of excess capacity 3. Change in legal-institutional environment Business taxes 3. Change in government spending a. Business taxes and subsidies 4. Change in net export spending a. National income abroad b. Exchange rates b. Government regulations