Macroeconomics Final Exam Study Guide: Aggregate Demand, Aggregate Supply, and Monetary Policy

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Chapter 11: Economic Growth

11.1 Economic Growth over Time and around the World

Economic growth refers to the sustained increase in a country's output of goods and services over time. It is typically measured by the growth rate of real Gross Domestic Product (GDP) per capita.

Key Point: Economic growth rates vary significantly across countries and historical periods.
Example: Developed countries like the United States have experienced higher long-term growth rates compared to many developing nations.

11.2 What Determines How Fast Economies Grow?

The speed of economic growth is influenced by several factors, including:

Physical capital accumulation (factories, machinery, infrastructure)
Human capital (education, skills, health of the workforce)
Technological progress (innovation, research and development)
Institutional factors (property rights, political stability, legal systems)

11.3 Economic Growth in the United States

The United States has experienced sustained economic growth due to high rates of capital formation, technological innovation, and a favorable institutional environment.

11.4 Why Isn’t the Whole World Rich?

Differences in economic growth rates explain why some countries remain poor while others become wealthy. Barriers include lack of access to capital, poor governance, and insufficient education.

11.5 Growth Policies

Policies to promote growth include investing in education, encouraging innovation, protecting property rights, and maintaining macroeconomic stability.

Chapter 13: Aggregate Demand and Aggregate Supply

13.1 Aggregate Demand

The aggregate demand (AD) curve shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government (both domestic and foreign).

Downward Slope Reasons:
1. The Wealth Effect: As the price level falls, the real value of money increases, leading to higher consumer spending.
2. The Interest Rate Effect: Lower price levels reduce interest rates, stimulating investment and consumption.
3. The International Trade Effect: Lower domestic prices make exports more attractive and imports less attractive, increasing net exports.

Shifts vs. Movements Along the AD Curve

Movement along the AD curve: Caused by a change in the price level, holding all else constant.
Shift of the AD curve: Caused by changes in components of real GDP (e.g., government purchases, taxes, investment, net exports).

Variables That Shift the Aggregate Demand Curve

An increase in...	Shifts the AD curve...	Because...
Interest rates	Left	Higher interest rates raise the cost of borrowing, reducing consumption and investment spending.
Government purchases	Right	Government purchases are a component of aggregate demand.
Personal income taxes or business taxes	Left	Consumption spending falls when personal taxes rise; investment falls when business taxes rise.
Growth rate of domestic GDP relative to foreign GDP	Left	Imports will increase faster than exports, reducing net exports.
Exchange rate (value of the dollar)	Left	Imports will rise and exports will fall, reducing net exports.

Example: If the Federal Reserve raises interest rates, investment spending will fall, shifting AD left.

13.2 Aggregate Supply

Aggregate supply refers to the quantity of goods and services that firms are willing and able to supply at different price levels. The relationship differs in the short run and long run.

Short-run aggregate supply (SRAS) curve: Shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms. The SRAS is upward sloping because input prices (like wages) adjust more slowly than output prices.
Long-run aggregate supply (LRAS) curve: Shows the relationship in the long run between the price level and the quantity of real GDP supplied. The LRAS is vertical at the level of potential or full-employment GDP, determined by resources, technology, and institutions.

The Long-Run Aggregate Supply Curve

LRAS is vertical because, in the long run, output is determined by the number of workers, technology, and capital stock—not by the price level.
Potential GDP increases over time as these factors grow.

The Short-Run Aggregate Supply Curve

SRAS is upward sloping because prices of final goods and services rise faster than input prices.
Some firms are slow to adjust prices, contributing to the upward slope.

Shifts of the SRAS Curve

Movement along SRAS: Caused by a change in the price level, holding other factors constant.
Shift of SRAS: Caused by changes in expectations, resource availability, or technology.

An increase in...	Shifts the SRAS curve...	Because...
Labor force or capital stock	Right	More output can be produced at any price level.
Productivity (technology)	Right	Costs of producing output fall.
Expected future price level	Left	Firms expect higher prices, so they increase wages and prices.
Price of an important natural resource	Left	Costs of production rise, reducing output.

Example: A sudden increase in oil prices (a supply shock) shifts SRAS left.

13.3 Macroeconomic Equilibrium in the Long Run and the Short Run

Macroeconomic equilibrium occurs where the AD and SRAS curves intersect. In the long run, equilibrium is at the intersection of AD, SRAS, and LRAS, with GDP at its full-employment level.

13.4 A Dynamic Aggregate Demand and Aggregate Supply Model

The dynamic AD-AS model incorporates ongoing growth in potential GDP, shifts in AD, and SRAS. It explains inflation as a result of total spending increasing faster than production.

AD and LRAS typically shift right each year due to growth.
SRAS also shifts right, except when high inflation is expected.
Inflation occurs when AD shifts further right than LRAS.

Chapter 14: Money, Banking, and the Federal Reserve

14.1 What Is Money, and Why Do We Need It?

Money serves as a medium of exchange, a unit of account, and a store of value, facilitating transactions and economic activity.

14.2 How Is Money Measured in the United States Today?

M1: The sum of currency in circulation, checking account deposits, and savings account deposits in banks (narrow definition).
M2: Includes M1 plus small-denomination time deposits and noninstitutional money market fund shares (broader definition).

14.3 How Do Banks Create Money?

Banks create money through the process of accepting deposits and making loans. This is known as the multiple expansion of deposits.

When a deposit is made, banks keep a fraction as reserves and lend out the rest, creating new deposits in the banking system.
This process is characteristic of a fractional reserve banking system.

14.4 The Federal Reserve System

The Federal Reserve (the Fed) is the central bank of the United States. It regulates banks, acts as a lender of last resort, and conducts monetary policy to manage the money supply and interest rates.

Bank run: When many depositors try to withdraw funds simultaneously due to loss of confidence.
Bank panic: When many banks experience runs at the same time.

14.5 The Quantity Theory of Money

The quantity theory of money relates the money supply to the price level and output in the economy.

Equation:
If the money supply grows faster than real GDP, there will be inflation.
If the money supply grows slower than real GDP, there will be deflation.
If the money supply grows at the same rate as real GDP, the price level will be stable.

Chapter 15: Monetary Policy

15.1 What Is Monetary Policy?

Monetary policy refers to the actions the Federal Reserve takes to manage interest rates and the money supply to achieve macroeconomic objectives.

15.2 The Federal Funds Rate and How the Fed Conducts Monetary Policy

The federal funds rate is the interest rate banks charge each other for overnight loans.
The Fed influences aggregate demand primarily through interest rates, especially the federal funds rate.
The Fed sets targets for the federal funds rate and uses various tools to achieve these targets.

Type of monetary policy	Purpose	Method
Expansionary	Increase the growth of aggregate demand, real GDP, and employment	Lower the target for the federal funds rate
Contractionary	Decrease the growth of aggregate demand, real GDP, and employment	Raise the target for the federal funds rate

15.3 Monetary Policy and Economic Activity

Lower interest rates encourage consumption and investment, increasing aggregate demand.
Higher interest rates discourage spending, reducing aggregate demand.

15.4 Monetary Policy in the Dynamic Aggregate Demand and Aggregate Supply Model

Monetary policy can shift the AD curve, affecting output and the price level in both the short run and the long run.

15.5 A Closer Look at the Fed's Setting of Monetary Policy Targets

The Fed uses different tools depending on the reserve regime:

Situation	Name	Method for controlling the federal funds rate
Banks keep as few reserves as regulations allow	Scarce-reserves regime	Adjust the supply of reserves
Banks keep more reserves than required	Ample-reserves regime	Adjust the interest rate on reserve balances (IORB)

15.6 Fed Policies during the 2007–2009 and 2020 Recessions

The Fed used unconventional tools such as quantitative easing and forward guidance to manage the economy during periods when interest rates were near zero.

Summary of the Fed's Monetary Policy Tools

Interest on reserve balances (IORB): Manages the federal funds rate.
Interest rate on overnight reverse repurchase agreements (ON RRP): Sets a lower bound on the federal funds rate.
Open market operations: Buying and selling Treasury securities to adjust reserves.
Discount rate: Interest rate for discount loans to banks.
Reserve requirements: Minimum reserves banks must hold (rarely used now).
Quantitative easing: Large-scale asset purchases when rates are near zero.
Forward guidance: Communicating future policy intentions to influence expectations.

How Interest Rates Affect Aggregate Demand

Consumption: Lower rates encourage credit purchases and reduce saving.
Investment: Lower rates make borrowing cheaper for firms and households.
Net exports: Lower U.S. rates reduce the exchange rate, increasing exports.

Expansionary vs. Contractionary Monetary Policy

Expansionary policy: Increases aggregate demand by lowering interest rates.
Contractionary policy: Decreases aggregate demand by raising interest rates.

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