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

Chapter 11: Economic Growth

11.1 Economic Growth over Time and around the World

Economic growth refers to the increase in the production of goods and services in an economy over time. It is typically measured by the growth rate of real Gross Domestic Product (GDP).

• Real GDP: The value of all final goods and services produced within a country in a given period, adjusted for inflation.

• Growth rates vary significantly across countries and over time, leading to differences in living standards.

• Example: The United States has experienced sustained economic growth over the past century, while some countries have seen little or no growth.

11.2 What Determines How Fast Economies Grow?

• Key determinants include increases in the quantity and quality of labor, capital accumulation, and technological progress.

• Production Function: $Y = A F(K, L)$, where $Y$ is output, $A$ is technology, $K$ is capital, and $L$ is labor.

• Institutions, such as property rights and political stability, also play a crucial role.

11.3 Economic Growth in the United States

• The U.S. has achieved high growth rates due to innovation, investment in human capital, and a favorable institutional environment.

11.4 Why Isn’t the Whole World Rich?

• Barriers to growth include lack of access to capital, poor governance, low levels of education, and political instability.

11.5 Growth Policies

• Policies to promote growth include investing in education, encouraging savings and investment, supporting research and development, and maintaining stable macroeconomic conditions.

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).

• The AD curve slopes downward due to:

  • Wealth Effect: As the price level falls, the real value of money increases, boosting consumer spending.

  • Interest Rate Effect: Lower price levels reduce interest rates, encouraging investment.

  • International Trade Effect: Lower domestic prices make exports more attractive and imports less attractive.

Shifts vs. Movements Along the AD Curve

• A movement along the AD curve is caused by a change in the price level, holding all else constant.

• A shift in the AD curve occurs when a component of real GDP (such as government spending or investment) changes for reasons other than the price level.

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 to the left.

13.2 Aggregate Supply

Aggregate supply refers to the total quantity of goods and services that firms are willing and able to supply at different price levels.

• The relationship between output and the price level differs in the short run and long run.

Short-Run Aggregate Supply (SRAS) Curve

• The SRAS curve shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms.

• SRAS is upward sloping because input prices (like wages) adjust more slowly than output prices.

• Some firms are slow to adjust their prices, contributing to the upward slope.

Long-Run Aggregate Supply (LRAS) Curve

• The LRAS curve is vertical at the level of potential or full-employment GDP.

• In the long run, output is determined by the number of workers, the level of technology, and the capital stock—not by the price level.

Shifts of the SRAS Curve

An increase in...	Shifts the SRAS curve...	Because...
Labor force or capital stock	Right	More output can be produced at every price level.
Productivity	Right	Costs of producing output fall.
Expected future price level	Left	Expecting higher prices leads workers and firms to increase wages and prices.
Price of an important natural resource	Left	Costs of production rise or many firms are forced to close.

• Supply shock: An unexpected event that causes the SRAS curve to shift (e.g., a sudden increase in oil prices).

13.3 Macroeconomic Equilibrium in the Long Run and the Short Run

• Short-run equilibrium occurs where AD and SRAS intersect.

• Long-run equilibrium occurs where AD, SRAS, and LRAS all intersect—GDP is at its full-employment level.

13.4 A Dynamic Aggregate Demand and Aggregate Supply Model

The dynamic AD-AS model incorporates continual increases in real GDP, shifting LRAS and AD to the right, and typically SRAS as well (except when inflation expectations are high).

• Inflation is usually caused by total spending increasing faster than production.

• Long-run equilibrium is restored at a higher price level if AD grows faster than LRAS.

Chapter 14: Money, Banking, and the Federal Reserve

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

• Money is any asset that can be easily used to purchase goods and services.

• Functions of money: medium of exchange, unit of account, store of value.

14.2 How Is Money Measured in the United States Today?

• M1: Currency in circulation + checking account deposits + savings account deposits.

• M2: M1 + small-denomination time deposits + noninstitutional money market fund shares.

14.3 How Do Banks Create Money?

• Banks operate under a fractional reserve banking system, keeping less than 100% of deposits as reserves.

• When a deposit is made, banks keep a fraction as reserves and lend out the rest, creating new deposits and expanding the money supply.

• Example: A $1,000 deposit with a 10% reserve requirement allows $900 to be lent out, which can be redeposited and lent again, leading to a money multiplier effect.

14.4 The Federal Reserve System

• The Federal Reserve (the Fed) is the central bank of the United States, responsible for regulating banks and conducting monetary policy.

• Bank run: When many depositors 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 real output.

• Equation: $\text{Inflation rate} = \text{Growth Rate of the Money Supply} - \text{Growth Rate of Real Output}$

• If the money supply grows faster than real GDP, there will be inflation; if slower, deflation; if equal, price stability.

Chapter 15: Monetary Policy

15.1 What Is Monetary Policy?

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

• Main goals: price stability, high employment, stability of financial markets, and economic growth.

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 mainly through interest rates, especially the federal funds rate.

• The Federal Open Market Committee (FOMC) sets targets for the federal funds rate.

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, and can also affect net exports by influencing the exchange rate.

• Higher interest rates have the opposite effect.

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

• Expansionary monetary policy shifts AD to the right, increasing output and the price level.

• Contractionary monetary policy shifts AD to the left, reducing output and the price level.

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

• The Fed uses various tools to influence the federal funds rate, including:

  • Interest on reserve balances (IORB)

  • Interest rate on overnight reverse repurchase agreements (ON RRP)

  • Open market operations

  • Discount rate

  • Reserve requirements (rarely used in recent years)

15.6 Fed Policies during the 2007–2009 and 2020 Recessions

• During crises, the Fed may use unconventional tools such as quantitative easing and forward guidance to influence long-term interest rates and expectations.

Key Diagrams and Tables

Aggregate Demand and Aggregate Supply Model

• Intersection of AD and SRAS determines short-run equilibrium output and price level.

• LRAS is vertical at potential GDP.

Summary Table: Factors Shifting AD and SRAS

Factor	Shifts AD	Shifts SRAS
Interest rates	Yes	No
Government purchases	Yes	No
Taxes	Yes	No
Labor force/capital	No	Yes
Productivity	No	Yes
Expected future price level	No	Yes
Natural resource prices	No	Yes

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