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 a country's output of goods and services over time, typically measured by real Gross Domestic Product (GDP). Growth rates vary significantly across countries and historical periods.

• Key Point: Sustained economic growth leads to higher living standards and improved quality of life.

• Example: The United States has experienced long-term economic growth, but rates have fluctuated due to technological changes, policy decisions, and global events.

11.2 What Determines How Fast Economies Grow?

The speed of economic growth is determined by factors such as capital accumulation, labor force growth, technological progress, and institutional quality.

• Key Point: Investment in physical capital, human capital, and technology are crucial for rapid growth.

• Formula: $\text{Economic Growth Rate} = \frac{\text{GDP}_{t} - \text{GDP}_{t-1}}{\text{GDP}_{t-1}} \times 100\%$

11.3 Economic Growth in the United States

The U.S. has experienced periods of rapid growth, especially during industrialization and the information age, but also faced recessions and slower growth phases.

• Key Point: Policy, innovation, and global integration have shaped U.S. growth patterns.

11.4 Why Isn’t the Whole World Rich?

Global disparities in income and wealth are due to differences in resources, institutions, education, technology, and policy environments.

• Key Point: Barriers to growth include poor governance, lack of infrastructure, and limited access to education and technology.

11.5 Growth Policies

Governments can promote growth through policies that encourage investment, innovation, education, and stable macroeconomic environments.

• Key Point: Examples include tax incentives for research and development, investment in public infrastructure, and support for education.

Chapter 13: Aggregate Demand and Aggregate Supply

13.1 Aggregate Demand

Aggregate demand (AD) is the total quantity of goods and services demanded across all sectors of an economy at different price levels.

• Definition: The aggregate demand curve shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government.

• Downward Slope Reasons:

  1. Wealth Effect: Higher price levels reduce the real value of money, decreasing consumption.

  2. Interest Rate Effect: Higher price levels lead to higher interest rates, reducing investment and consumption.

  3. International Trade Effect: Higher domestic prices make exports less competitive, reducing net exports.

13.2 Aggregate Supply

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

• 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.

• Long-run aggregate supply (LRAS) curve: Shows the relationship in the long run between the price level and the quantity of real GDP supplied. LRAS is vertical at the level of potential or full-employment GDP.

13.3 Macroeconomic Equilibrium in the Long Run and the Short Run

Macroeconomic equilibrium occurs where aggregate demand and aggregate supply intersect. In the long run, equilibrium is at the LRAS, representing full employment.

• Key Point: Short-run equilibrium can differ from long-run equilibrium due to temporary shocks or price/wage rigidities.

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 during periods of high inflation expectations.

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

• Formula: $\text{Long-run equilibrium:} \quad AD = SRAS = LRAS$

Variables That Shift the Aggregate Demand Curve

An increase in...	Shifts the AD curve...	Because...
Interest rates	Left	Higher rates raise borrowing costs, reducing consumption and investment.
Government purchases	Right	Government purchases are a component of aggregate demand.
Personal income taxes/business taxes	Left	Higher taxes reduce disposable income and investment.
Growth rate of domestic GDP relative to foreign GDP	Left	Imports rise faster than exports, reducing net exports.
Exchange rate (value of $US)	Left	Exports become more expensive, reducing net exports.

Variables That Shift the Short-Run Aggregate Supply 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	Firms expect higher costs, so they increase prices and wages.
Price of an important natural resource	Left	Costs of production rise, reducing output.

Supply Shock

• Definition: An unexpected event that causes the SRAS curve to shift, such as a sudden increase in oil prices or a pandemic.

• Example: The COVID-19 pandemic caused a negative supply shock, reducing output.

Chapter 14: The Monetary System

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

Money is any asset that is widely accepted as payment for goods and services. It serves as a medium of exchange, a unit of account, and a store of value.

• Key Point: Money facilitates trade and economic activity by eliminating the need for barter.

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 create money through the process of accepting deposits and making loans, known as fractional reserve banking.

• Key Point: Banks keep less than 100% of deposits as reserves, lending out the rest and thereby expanding the money supply.

• Example: A $1,000 deposit can lead to a $1,900 increase in deposits through multiple rounds of lending.

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.

• Key Point: The Fed acts as a lender of last resort to prevent bank panics and manages the money supply.

• Definitions:

  • Bank run: Many depositors withdraw funds simultaneously due to loss of confidence.

  • Bank panic: Multiple 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.

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

• Key Point: If the money supply grows faster than real GDP, inflation occurs; if slower, deflation occurs; if equal, the price level is stable.

Chapter 15: Monetary Policy

15.1 What Is Monetary Policy?

Monetary policy refers to the actions taken by the central bank to manage interest rates and the money supply to achieve macroeconomic objectives.

• Goals:

  1. Price stability

  2. High employment

  3. Stability of financial markets and institutions

  4. 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 primarily through changes in interest rates.

• Key Point: Lowering the federal funds rate stimulates aggregate demand; raising it slows aggregate demand.

How the Fed Uses the Federal Funds Rate

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

Controlling the Federal Funds Rate

Situation	Name	Method
Banks keep few reserves	Scarce-reserves regime	Adjust supply of reserves
Banks keep more reserves than required	Ample-reserves regime	Adjust interest rate on reserve balances (IORB)

15.3 Monetary Policy and Economic Activity

Monetary policy affects aggregate demand through its impact on consumption, investment, and net exports.

• Consumption: Lower interest rates encourage borrowing and spending.

• Investment: Lower rates make capital investment more attractive.

• Net exports: Lower U.S. interest rates reduce the exchange rate, increasing net exports.

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

Expansionary monetary policy shifts AD to the right, increasing output and price level; contractionary policy shifts AD to the left, reducing output and price level.

• Key Point: The effects are relative to what would have happened without the policy.

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

• Interest on reserve balances (IORB): Used to manage the federal funds rate.

• Interest rate on overnight reverse repurchase agreements (ON RRP): Sets a lower bound on the federal funds rate.

• Quantitative easing: Used when rates are at the zero lower bound.

• Forward guidance: Signals intent to keep rates low for a prolonged period.

• Open market operations: Buying and selling Treasury securities to adjust reserves.

• Discount rate: Rate charged for discount loans to banks.

• Reserve requirements: Minimum percentage of deposits banks must hold as reserves (not actively used since 2020).

Expansionary vs. Contractionary Monetary Policy

Policy Type	Action	Effect on AD	Effect on GDP/Price Level
Expansionary	Lower federal funds rate	Increase	Higher GDP and price level
Contractionary	Raise federal funds rate	Decrease	Lower GDP and price level

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