Business Cycle

● Expansion is also called recovery

● Peaks occur during an inflationary gap and can bring high inflation
● Contractions longer than 6 months are recessions
● Troughs occur during an expansionary gap and can bring high unemployment and deflation

Phillips Curve

● LRPC lies at the Natural Rate of Unemployment (Full Employment)

● Changes in AD cause movement along the SRPC
● Changes in AS cause a shift in the SRPC
● Changes in inflation expectations cause SPRC to shift

Foreign Exchange Market

○ Causes of a shift in a demand or supply for a currency:

■ Changes in interest rates
■ Changes in expected future exchange rate
■ Changes in inflation rate
■ Changes in DI (Disposable Income) ← Affected by GDP
○ Any increase in demand for one currency will always cause a decrease in the supply, and a decrease in demand
but an increase in supply for the other currency.
 AS/AD Graph

● LRAS = Full employment level of output

● LRAS may shift if there is an increase/decrease in capital investment
● Inflationary Gap = Output > LRAS
● Recessionary Gap = Output < LRAS
● AD = GDP = C + I + G + (X-M)
● The FED can use Monetary Policy and the government can use Fiscal Policy to shift AD
● LRAS shifts from anything that would move the PPC (Production Possibilities Curve)
● If the economy is in disequilibrium, workers will eventually get higher (Inflationary) or lower (Recessionary) wages,
changing input prices, causing a shift in AS towards long-run equilibrium.

Loanable Funds

● How much money is being saved in the economy shows the supply of loanable funds
● Demand for LF is the amount of investment businesses would like to make
● An increase in government spending decreases the supply of loanable funds, which creates a higher interest rate
(Crowding Out)
● A decrease in government spending increases the supply of loanable funds, which creates a lower interest rate.
● Interest rates affect “I” in GDP, so a change in interest rates will cause a shift in AD.
● The Foreign Exchange Market can also affect loanable funds

SRAS Curve

● An economy in the Keynesian part of the SRAS curve can

increase output without increasing price level
 ● An economy in the Intermediate part of the SRAS curve can increase output while increasing price level
● An economy in the Classical part of the SRAS curve cannot increase output, only price levels.

Money Market

● MS is the amount of money in the economy, a sum of M1 and M2.

● The Federal Reserve regulates the money supply through Open Market Operations (Buying and selling bonds and
securities), discount rate, and reserve requirement.
● Expansionary monetary policy shifts MS to the right
● Contractionary monetary policy shifts MS to the left
● MD can move from transactions in an economy or due to a change in the desire to hold cash as a liquid asset.

Interest Rates Graph

● Dm, or total demand for money, equals transaction demand plus asset demand. Sm is always vertical because quantity
supplied doesn’t vary with the rate of interest.
● Inflationary Situation is when the Sm shifts left
○ If supply of money decreases, then the rate of interest increases. Then, when the rate of interest increases, the
amount of investment decrease
● Recessionary Situation is when the Sm shifts right
○ If supply of money increases, then the rate of interest decreases. Then, when the rate of interest decreases, the
amount of investment increases.

Fiscal Policy
➔ Expansionary (increase in gov. spending or decrease in taxes)
◆ Increase in consumption (due to an increase in disposable income), aggregate demand, price level, rGDP
◆ Decreases unemployment
➔ Contractionary (decrease in gov. spending or increase in taxes)
◆ Decreases consumption (due to an decrease in disposable income), aggregate demand, price level, and RGDP
◆ Increases unemployment
Spending, Tax, and Balanced Budget Multiplier
➔ Spending Multiplier
◆ 1MPS
➔ Tax Multiplier
◆ Spending multiplier - 1 OR(1MPS)-1
➔ Balanced Budget Multiplier
◆ Always = 1
◆ Equal to spending multiplier - tax multiplier
➔ MPC + MPS = 1

Crowding Out Effect

➔ An economic theory that says that rises in government involvement drive down or even eliminate private spending

Interest Rates and Long Run Growth

➔ Situation 1
◆ Interest Rates (Decrease), Investment (Increase)
● Capital Stock Grows
● LRAS Shifts Right
● PPC Shifts Outward
➔ Situation 2
◆ Interest Rates (Increase), Investment (Decrease)
● Capital Stock Falls
● LRAS Shifts Left
● PPC Shifts Inward

Monetary Policy
➔ If the economy is in recession
◆ The FED buys bonds
● Money supply increases
● Nominal interest rates decreases
● Investment spending increases
● Aggregate demand, price level, rGDP all increase
● Unemployment decreases
● Bond prices increase
➔ If the economy is experiencing inflation
◆ The FED sells bonds
● Money supply decreases
● Nominal interest rates increase
● Investment spending decreases
● Aggregate demand, price level, GDP all decrease
● Unemployment increases
● Bond prices decrease
➔ “Buy Big; Sell Small”
◆ Buying bonds results in a bigger money supply
◆ Selling bonds results in a smaller money supply

The Money Multiplier

➔ 1/Reserve Ratio
◆ Ex. If Reserve requirement is 10%
● 1X10 = 10
➔ Change in money supply from Open Market Operations
◆ Bond purchase Money multiplier
◆ Bond sale Money multiplier
➔ Change in money supply from demand deposits
◆ Excess reserves Money multiplier
➔ Change in total deposits from demand deposit
◆ Deposit Money Multiplier

Unanticipated Inflation
➔ Winners:
◆ People making fixed payments, their real wages increase when inflation decreases
➔ Losers:
◆ People receiving fixed payments, their real wages decrease when inflation increases
➔ Real Interest Rate = Nominal Interest Rate - Expected Inflation
Interest Rates and Currency Value (FOREX)
➔ If interest rates are up
◆ International demand for bonds increases
◆ Demand for currency increases
◆ Currency Appreciates
➔ If interest rates are down
◆ International demand for bonds decreases
◆ Demand for currency decreases
◆ Currency Depreciates

The Relationship between the Phillips Curve and AD/AS

➔ Everything works in opposite directions
➔ If AD shifts right
◆ Point movement to the left on SRPC
➔ If AD shifts left
◆ Point movement to the right on SRPC
➔ If SRAS shifts right
◆ SRPC shifts to the left
➔ If SRAS shifts left
◆ SRPC shifts to the right

AS/AD in the Long Run

➔ Recession
◆ Nominal wages decrease
◆ SRAS increases
◆ Price level decreases
◆ RGDP increases
◆ Unemployment decreases
➔ Inflation
◆ Nominal wages increase
◆ SRAS decreases
◆ Price level increases
◆ RGDP decreases
◆ Unemployment increases
◆ Purchasing power decreases

Shifters of the Production Possibilities Curve

➔ Economic growth or disaster
➔ Increase/Decrease in resources
➔ Technological changes

Absolute vs. Comparative Advantages

➔ Absolute Advantage
◆ A country can produce goods at a lower cost in comparison to another
➔ Comparative Advantage
◆ A country produces particular goods at a lower opportunity cost in comparison to other countries

A Bunch of Definitions/Concepts/Calculations:
➔ National Income Accounting
◆ A term used to refer to the bookkeeping system that a national government uses to measure the country’s
current economic activity in a given time period.
➔ Calculating Percent Change in Real GDP
◆ ([Current Year GDP - Base Year GDP] Base Year GDP)100

➔ CPI Calculation
◆ (Cost of market basket of current year Cost of market basket of base year)100

➔ Inflation Rate Calculation

◆ ([CPI Current Year-CPI Last Year]CPI Last Year)100

➔ Investment
◆ An asset or item that is purchased with the hope that it will generate income or appreciate in the future

➔ Intermediate Goods
◆ Producer goods that are semi-finished, which are then used in the production of other goods.
➔ Household Production

◆
◆
➔ Nominal vs. Real GDP
◆ Nominal GDP
● GDP figure that has not been adjusted for inflation
◆ Real GDP
● GDP figure that has been adjusted for inflation
➔ Labor Force
◆ Employed workers+Unemployed Workers
● Unemployed Workers
○ A labor force participant who is willing and able to work, and has been looking for a job for at
least 4 weeks
➔ Frictional Unemployment
◆ Occurs as unemployed workers and firms search for the best available worker-job matches
➔ Cyclical Unemployment
◆ Results of downturns in the business cycle
◆ Full employment occurs when cyclical unemployment is 0
➔ Structural Unemployment
◆ Result of a skills mismatch
➔ Natural Rate of Unemployment
◆ The typical rate of unemployment in a normally functioning economy
◆ The sum of frictional and structural unemployment
➔ Discouraged Workers
◆ Those who are able and willing to work, but become frustrated from a lack of work and stop trying
➔ Unemployment Rate
◆ (# Unemployed# In Labor Force)100
➔ Types of Resources
◆ Land
◆ Capital
◆ Labor
◆ Entrepreneurial ability
➔ Income Approach to GDP
◆ GDP = Compensation of employees + Rents + Interest + Proprietors’ income + Corporate profits (Corporate
income taxes + dividends + undistributed corporate profits) + indirect business taxes + depreciation
(consumption of fixed capital) + net foreign factor income
➔ GDP Growth
◆ ([New GDP-Old GDP]Old GDP)100
➔ Types of Inflation
◆ Demand-pull inflation: more spending than the economy’s capacity to produce. The excess demand increases
the prices of the limited real output, causing prices to rise.
◆ Cost-Push (Supply-side) inflation: Per-unit production costs (total input cost ÷ units of output) rise, reducing the
amount of companies willing to sell products at the current price level. Then, supply decreases, causing the
price level to increase.
➔ Rule of 70
◆ If we divide 70 by the annual rate of inflation, this quotient is the number of years it takes for inflation to double
the price level.
➔ Okun’s Law
◆ For every 1 percentage point that the actual unemployment rate exceeds the natural rate, a GDP gap of about
2% occurs.

➔ Law Of Demand
◆ Inverse relationship between price and quantity demanded

➔ Law Of Supply
 ◆ Direct relationship between price and quantity supplied

➔ MPS and MPC

◆ MPS+MPC=1
◆ MPS
● Change in SavingChange in Income
◆ MPS
● Change in ConsumptionChange in Income

➔ M1, M2, M3
◆ M1 is the narrowest definition of money supply. It includes currency (coins + paper money), travelers checks,
and checkable deposits
◆ M2 includes M1 plus near-monies (highly liquid financial assets which do not directly function as a medium of
exchange but can be readily converted into currency or checkable deposits without risk of financial loss). The
non-monies included are non checkable savings accounts, money market deposit accounts, small time deposits,
and money market mutual funds
◆ M3 is M2 plus large time deposits.

➔ Stagflation
◆ It is increasing inflation and rising unemployment in an economy at the same time.
◆ It is usually caused by a decrease in AS (supply-shock inflation).