MACROECONOMICS VDT 2012

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THE EFFECTS OF CHANGING FACTORS

1. MARKET FOR LOANABLE FUNDS IN CLOSE ECONOMY:
- Supply of loanable funds: S
- Demand of loanable funds: I
- Price of a loan: real interest rate.
- Equilibrium: S = I

A. Changing real interest rate: (endogenous factor)
- r quantity of supply of loanable funds and quantity of demand of
loanable funds
- r quantity of supply of loanable funds and quantity of demand of
loanable funds

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B. Changing tax on saving (exogenous factor) (S)
- Tax on saving encourage saving S shifts right r and
quantity of loanable funds
- Tax on saving discourage saving S shifts left r and
quantity of loanable funds

C. Changing tax on investment (exogenous factor) (D)
- Tax on investment discourage investment D shifts left r
and quantity of loanable fund
- Tax on investment or investment tax credit encourage investment
D shifts right r and quantity of loanable fund

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D. Changing government budget (exogenous factor) (S)
- Government budget deficit public saving national saving S
shifts left r and quantity of loanable funds crowding-out
effect I
- Government budget surplus public saving national saving
S shifts right r and quantity of loanable funds
2. MONEY MARKET (CLASSICAL THEORY - LONG-RUN)
- Money supply: fixed by central bank
- Money demand: downward sloping
- Horizontal axis: Quantity of money
- Vertical axis: 1/P
- Equilibrium: MS = MD

A. Changing price level (endogenous factor)
- P not affect MS and quantity of money demand
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- P not affect MS and quantity of money demand

B. Changing money supply (monetary injection) (exogenous factor)
- Central bank increases money supply MS shifts right (1/P)
meaning value of money P and quantity of money
- Central bank decreases money supply MS shifts left (1/P)
meaning value of money P and quantity of money

3. MONEY MARKET (KEYNES THEORY - SHORT-RUN)
- Money supply: fixed by central bank
- Money demand: downward sloping
- Horizontal axis: Quantity of money
- Vertical axis: interest rate.
- Equilibrium: MS = MD

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A. Changing interest rate (endogenous factor)
- r not affect MS and quantity of money demand
- r not affect MS and quantity of money demand
B. Theory of liquidity preference
- r > equilibrium surplus buy interest-bearing assets r until
equilibrium.
- r < equilibrium shortage sell interest-bearing assets r until
equilibrium.
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C. Changing money supply (monetary injection) (exogenous factor)
- Central bank increases money supply MS shifts right r and
quantity of money
- Central bank decreases money supply MS shifts left r and
quantity of money

D. Changing price level (exogenous factor) (MD)
- P MD shifts right r and quantity of money unchanged
- P MD shifts left r and quantity of money unchanged

4. MARKET FOR LOANABLE FUNDS IN OPEN ECONOMY THE RELATION
BETWEEN INTEREST RATE AND NCO FOREIGN-CURRENCY
EXCHANGE MARKET
A. MARKET FOR LOANABLE FUNDS IN OPEN ECONOMY (GRAPH 1)
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- Supply of loanable funds: S
- Demand of loanable funds: I + NCO
- Price of a loan: real interest rate.
- Equilibrium: S = I + NCO

Changing real interest rate: (endogenous factor)
- r quantity of supply of loanable funds , quantity of demand of
loanable funds and NCO
- r quantity of supply of loanable funds , quantity of demand of
loanable funds and NCO

B. THE RELATION BETWEEN INTEREST RATE AND NCO (GRAPH 2)
- NCO curve: sloping downward
- Horizontal axis: NCO
- Vertical axis: real interest rate
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Changing in interest rate:
- r domestic assets more attractive NCO
- r domestic assets less attractive NCO

C. MARKET FOR FOREIGN- CURRENCY EXCHANGE (GRAPH 3)
- Supply: Supply of Dollars NCO vertical and not depend on real
exchange rate.
- Demand: Demand of Dollars NX Sloping downward
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- Horizontal axis: Quantity of Dollars
- Vertical axis: real exchange rate
- Equilibrium: NCO = NX
Changing in real exchange rate:
- e domestic good more expensive reduce quantity of Dollars
demand to buy those goods.
- e domestic good cheaper rise quantity of Dollars demand to
buy those goods.
D. EQUILIBRIUM IN OPEN ECONOMIC EQUILIBRIUM IN TWO
MARKET FOR LOANABLE FUNDS AND FOREIGN-CURRENCY
EXCHANGE.
E. Equilibrium in graph 1: real interest rate determine NCO in graph 2 and
NCO in graph 2 determine supply of Dollars in graph 3

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Government budget deficits
- Government budget (deficit or G ) Public saving (T G)
national saving Supply of loanable funds shifts left (graph 1) r
crowd-out domestic investment ( I ) NCO (graph 2)
supply of Dollars (graph 3) e NX trade balance (deficit)
( twin deficit)
Trade policy (tariff, quota)
- Only affect in foreign-currency exchange: IM NX Demand for
Dollar e discourage export (EX until equal to NCO) no
change in NX, r and NCO
Capital flight and political instability
- Capital suddenly flow out of domestic economy NCO comes with
demand for loanable funds (graph 1) and NCO shifts right (graph 2)
r and NCO supply of domestic currency shifts right (graph 3)
e and quantity of domestic currency




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5. AGGREGATE DEMAND AGGREGATE SUPPLY PHILLIPS CURVE
A. AGGREGATE DEMAND
- AD: Y = C + I + G + NX
- Horizontal axis: Y (reflect unemployment)
- Vertical axis: P (reflect inflation)
Change in Price level (endogenous factor)
o Wealth effect (C): P real value of money Consumer
wealthier C increase quantity of demand for goods and
services (moving along AD curve).
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o Interest rate effect (I): P r I increase quantity
of demand for goods and services (moving along AD curve).
o Exchange rate effect (NX): P r NCO Supply of
Dollars shifts right e NX increase quantity of demand
for goods and services (moving along AD curve).
Change in exogenous factor:
o Change in C: C when consumers save more, stock prices fall so
consumers feel poorer, Taxes are increased AD shifts left;
and vice versa, C when consumers save less, stock prices rise
so consumer feel wealthier, Taxes are decreased AD shifts
right.
o Change in I: I when firms become optimistic about the future
and decide to buy new equipment, investment tax credit, central
bank increase MS lead to reduce r AD shifts right; and vice
versa I when investment tax increase, central bank decrease
MS lead to rise r AD shifts left.
o Change in G: G AD shifts right and G AD shifts left.
o Change in NX: NX when NCO or value of dollar fall; and vice
versa, NX when have a recession in foreign countries or value
of Dollar rise.
B. LONG-RUN AGGREGATE SUPPLY
- LRAS: - potential output full-employment output Output at
natural unemployment level.
- LRAS is vertical curve
- Horizontal axis: Y (reflect unemployment)
- Vertical axis: P (reflect inflation)
Change in Price level (endogenous factor)
- Does not affect LRAS and in long-run: Actual price = Expected price
Change in exogenous factor:
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o LRAS shifts right when labor (immigration from abroad or
reduction in un from minimum wage ), Capital (human and
physical capital productivity ), Natural resource and
technical Knowledge
o LRAS shifts right when labor (emigration from abroad or
increase in un from minimum wage ), Capital (weather)
C. SHORT-RUN AGGREGATE SUPPLY
- SRAS: Y = + a (P P
e
) = ( a.P
e
) + a.P
- SRAS: sloping upward
- Horizontal axis: Y (reflect unemployment)
- Vertical axis: P (reflect inflation)
Change in Price level (endogenous factor):
o The misperception theory: P actual suppliers only notice
that P of their particular product they believe that Relative
Price of their product quantity of goods and services
o The sticky-wave theory: P actual real wave w/P
cost of production lowering profits firms hire less labor
Quantity of good and services
o The sticky-price theory: P actual Firms resist reducing
their prices (menu costs) Their P too high their sales
quantity of goods and services
Change in exogenous factor:
o Change in : have same reason like LRAS.
o Change in P
e
: P
e
SRAS shifts left and P
e
SRAS
D. PHILLIPS CURVE
- LR Phillips curve: u = un
- SR Phillips curve: u = un a(
e
) = (un + a.
e
) a.
- Horizontal axis: unemployment
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- Vertical axis: inflation
Change in AD (endogenous factor) ( the short-run tradeoffs)
- AD shifts right P and Y and u
- AD shifts left P and Y and u

Change in SRAS (exogenous factor):
- Change in un: that is change in
- Change in
e
: that is change in P
e

- SRAS shift left Phillips curve shift right
- SRAS shift right Phillips curve shift left

E. AD AS MODEL
- Equilibrium in Short-run: AD = SRAS
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- Equilibrium in Long-run: AD = SRAS = LRAS at

Change in AD: (Demand shock)
o AD shifts left: P and Y u
o AD shifts left: P and Y u
Change in ARAS (Supply shock)
o SRAS shifts left (adverse shock): P and Y u
o SRAS shifts left (favorable shock): P and Y u

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6. INVISIBLE AND VISIBLE HAND
- Invisible hand: the market automatically adjust by shifting SRAS
- Visible hand: Government and central bank use their policies to shifting
AD
A. Demand Shock AD shift left
- Equilibrium in short-run: P < P
e
and Y <
- Invisible hand:
o Process: Y < u > un w Cost of Production SRAS
shift right until u = un and Y =
o New long-run equilibrium: Y = and Pe
- Visible hand:
o Process: Government and central bank shift AD right
o Long-run equilibrium: unchanged

B. Demand Shock AD shift right
- Equilibrium in short-run: P > P
e
and Y >
- Invisible hand:
o Process: Y > u < un w Cost of Production SRAS
shift left until u = un and Y =
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o New long-run equilibrium: Y = and Pe
- Visible hand:
o Process: Government and central bank shift AD left
o Long-run equilibrium: unchanged

C. Favorable Supply Shock AS shift right
- Equilibrium in short-run: P < P
e
and Y >
- Invisible hand:
o Process: Y > u < un w Cost of Production SRAS
shift left until u = un and Y =
o Long-run equilibrium: unchanged
- Visible hand:
o Process: Government and central bank shift AD left
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New Long-run equilibrium: Y = and P
e

D. Adverse Supply Shock AS shift left
- Equilibrium in short-run: P > P
e
and Y <
- Invisible hand:
o Process: Y < u > un w Cost of Production SRAS
shift right until u = un and Y =
o Long-run equilibrium: unchanged
- Visible hand:
o Process: Government and central bank shift AD left
o New Long-run equilibrium: Y = and P
e

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7. MONETARY POLICY (BY CENTRAL BANK)
A. Open market operation:
o Open market purchase: Central bank buy government bonds
MS r I AD shifts right.
o Open market sell: Central bank sell government bonds MS
r I AD shifts left.
B. Reserve requirement:
a. Reserve requirement money multiplier (1/R) MS
r I AD shifts right
b. Reserve requirement money multiplier (1/R) MS
r I AD shifts left.
C. The discount rate:
a. Discount rate MS r I AD shifts right
b. Discount rate MS r I AD shifts left.

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8. MULTIPLIER EFFECT INVESTMENT ACCELERATOR CROWDING-
OUT EFFECT AND THE SHIFT OF AD
A. Multiplier effect:
- When C or I or G (not by changing in price level) Y (AD shift
right) meaning that income C Y C and T Yd
meaning C Y C so AD shift right by an amount larger
than initial changing in C, I, G
- When C or I or G (not by changing in price level) Y (AD shift
left) meaning that income C Y C and T Yd
meaning C Y C so AD shift left by an amount larger
than initial changing in C, I, G
B. Investment accelerator:
- Y (AD shift right by C, I, G or T) Firms increase their
investment expenditures on new equipment I
- Y (AD shift left by C, I, G or T) Firms reduce their investment
expenditures on new equipment I
C. Crowding-out effect:
- Y (AD shift right by C, I, G or T) need more money to buy
goods and services MD shift right r I
- Y (AD shift left by C, I, G or T) need less money to buy goods
and services MD shift left r I
D. Changing in output and the effects to Investment.
- Y I (investment accelerator) but I (crowding-out effect)
- Y I (investment accelerator) but I (crowding-out effect)
E. Automatic stabilizers.
- Tax system: During recession (AD shifts left), T (because Y and
Profits ) Yd C Y AD shifts right.
- Government spending: During recession (AD shifts left), G
(unemployment benefits and welfare payment ) Y AD shifts
right.

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9. FISCAL POLICY (BY GOVERMENT)
A. Government purchase:
- G
o G Y C ( Y - multiplier effect) and I (investment
accelerator)
o G Y MD shifts right r I (crowding-out effect)
o r NCO supply of Dollars e NX
- G
o G Y C ( Y - multiplier effect) and I (investment
accelerator)
o G Y MD shifts left r I (crowding-out effect)
o r NCO supply of Dollars e NX


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B. Tax
- T
o T C Y C ( Y - multiplier effect) and I
(investment accelerator)
o T Y MD shifts right r I (crowding-out effect)
o r NCO supply of Dollars e NX
- T
o T C Y C ( Y - multiplier effect) and I
(investment accelerator)
o T Y MD shifts left r I (crowding-out effect)
o r NCO supply of Dollars e NX