macro economics

CL4 English Language CL4 English Language and Culture for Businessand Culture for Business

Module IV B2Module IV B2

European Economic PolicyEuropean Economic Policy

Dr. Peter CullenDr. Peter Cullenwww.cl4englishlistening.wordpress.comwww.cl4englishlistening.wordpress.com

The Balance of the Nation StateThe Balance of the Nation State

Aggregate Demand:Aggregate Demand:

ADAD is the relationship between the quantity of is the relationship between the quantity of aggregate output in demand and the aggregate aggregate output in demand and the aggregate price level.price level.

It is the the quantity of goods and services that It is the the quantity of goods and services that individuals want to buy at any given price levelindividuals want to buy at any given price level

Terminology: Terminology: SupplySupplyDemandDemandAggregateAggregateOutputOutputTransaction CostsTransaction Costs


The quantitative theory of money:The quantitative theory of money:

MV = PYMV = PY

where where MM = the supply of money = the supply of moneyVV = the velocity of circulation = the velocity of circulationP = price levelP = price levelY = the quantity of aggregate outputY = the quantity of aggregate output

If the velocity of circulation is constant, the supply of If the velocity of circulation is constant, the supply of money determines the nominal value of the product money determines the nominal value of the product which, in turn, is the product of the quantity of which, in turn, is the product of the quantity of aggregate product and the price.aggregate product and the price.


The quantitative theory of money can be re-written in The quantitative theory of money can be re-written in terms of supply and demand in real money balances:terms of supply and demand in real money balances:

M/P = (M/P)M/P = (M/P)dd = kY = kY

where where KK = 1/ = 1/VV is a parameter that measures the quota is a parameter that measures the quota of an income unit that individuals want to keep in of an income unit that individuals want to keep in liquid form (ready cash).liquid form (ready cash).

SO, the supply of real money balances SO, the supply of real money balances M/PM/P is equal to is equal to the demand for real money balances the demand for real money balances (M/P)(M/P)dd which is which is proportional to output proportional to output YY. The velocity of money . The velocity of money circulation circulation V V is the denominator of the parameter of is the denominator of the parameter of real money balances real money balances k = savings/€ of incomek = savings/€ of income


So, for any given supply of money and any given So, for any given supply of money and any given velocity of circulation, this equation identifies an velocity of circulation, this equation identifies an inverse relation between the price level inverse relation between the price level P P and the and the aggregate output aggregate output Y.Y.

P

AD

Income, Output, Y

P

Income, Output, Y

Reducing the money supplypushes theaggregate demandcurve to the left

DA1

DA2

The Balance of the Nation StateThe Balance of the Nation StateDon’t forget:Don’t forget:

Short termShort term: price viscosity or “stickyness” resulting : price viscosity or “stickyness” resulting in less-than-full employment and capital investmentin less-than-full employment and capital investmentPrice viscosity is important in explaining monthly Price viscosity is important in explaining monthly and yearly fluctuations.and yearly fluctuations.

Long termLong term: classic theory of money, classic theory of : classic theory of money, classic theory of the open economy; hypothesised price flexibility and the open economy; hypothesised price flexibility and full employment and quantities of money, labour and full employment and quantities of money, labour and technology are determinant. Time frame: a few technology are determinant. Time frame: a few years. Prices adjust to equilibrium while available years. Prices adjust to equilibrium while available capital, labour and technologies are relatively capital, labour and technologies are relatively constant.constant.

Very long termVery long term: growth theory (Solow) capital, : growth theory (Solow) capital, labour and technology vary. Time frame: decadeslabour and technology vary. Time frame: decades


Aggregate Supply: Aggregate Supply:

The The ASAS curve and the curve and the ADAD curve together define the curve together define the price level and the volume of output.price level and the volume of output.

ASAS is the relationship between the quantity of goods is the relationship between the quantity of goods and services offered and the price level. BUT, given and services offered and the price level. BUT, given that companies have flexible prices in the long-term that companies have flexible prices in the long-term and viscous prices in the short-term, the and viscous prices in the short-term, the AS AS curve curve depends on the time horizon.depends on the time horizon.

It is necessary to analyse TWO types of It is necessary to analyse TWO types of ASAS curve: short curve: short term (term (STASSTAS) and long-term () and long-term (LTASLTAS).).


The long-term:The long-term:

The quantity of output depends on the quantity of The quantity of output depends on the quantity of capital and labour – which are fixed – and on capital and labour – which are fixed – and on available production technologies.available production technologies.

So: So: Y = FY = F((¯ ,¯¯ ,¯) = ¯ where the ¯ symbol indicates the ) = ¯ where the ¯ symbol indicates the long-term valuelong-term value

The Long-Term Aggregate Supply curve is verticle since The Long-Term Aggregate Supply curve is verticle since capital and labour are fixed.capital and labour are fixed.

KK LL YY

The Balance of the Nation StateThe Balance of the Nation StateIf the money supply decreases, the aggregate demand If the money supply decreases, the aggregate demand

curve shifts to the left. The economy shifts from its curve shifts to the left. The economy shifts from its departure equilibrium (A) determined by the departure equilibrium (A) determined by the intersection of the aggregate supply curve to a new intersection of the aggregate supply curve to a new equilibrium point (B).equilibrium point (B).

The verticle Aggregate Supply curve implies that the The verticle Aggregate Supply curve implies that the volume of aggregate supply is independent of the volume of aggregate supply is independent of the money supply.money supply.

The long-term volume of Aggregate Supply The long-term volume of Aggregate Supply ¯ is called ¯ is called the the full employment levelfull employment level or or natural level of natural level of aggregate supplyaggregate supply – corresponding to the level at – corresponding to the level at which all resources in the economy are completely which all resources in the economy are completely employed.employed.

In real terms, this means that unemployment is at its In real terms, this means that unemployment is at its natural rate.natural rate.

YY


Short-term Aggregate Supply:Short-term Aggregate Supply:

Prices are viscous in the short-term, so they don’t Prices are viscous in the short-term, so they don’t instantly to variations in demand – so the short-term instantly to variations in demand – so the short-term aggregate supply curve cannot be verticle.aggregate supply curve cannot be verticle.

I.E. If companies publish their catalogues, then prices I.E. If companies publish their catalogues, then prices are fixed at a predetermined level and companies try are fixed at a predetermined level and companies try to sell as much as their clients wish to purchase, to sell as much as their clients wish to purchase, using labour to produce the quantity in demand.using labour to produce the quantity in demand.

This creates a horizontal Aggregate Supply Curve.This creates a horizontal Aggregate Supply Curve.


Short-term equilibrium in an economy is the point at Short-term equilibrium in an economy is the point at which the aggregate demand curve intersects the which the aggregate demand curve intersects the short-term aggregate supply curve.short-term aggregate supply curve.

A drop in aggregate demandP

Income, output, Y

STASBB AA

DA1

DA2

Viscousshort-termprices

Output drops


SO: when aggregate demand drops, aggregate output SO: when aggregate demand drops, aggregate output also drops, but due to viscous prices, companies are also drops, but due to viscous prices, companies are stuck with prices that are too high, causing an over-stuck with prices that are too high, causing an over-abundance of labour and:abundance of labour and:

Lay-offs/firing/downsizingLay-offs/firing/downsizing

RecessionRecession


So – how to economies make the shift from short-term So – how to economies make the shift from short-term to long-term?to long-term?

AA

BB

CC

STAS

DA1

DA2

1. A drop in aggregate demand1. A drop in aggregate demand

2. Forces2. Forcesdown outputdown outputin the shortin the shorttermterm

3. But in the long run 3. But in the long run affects only pricesaffects only prices

Y Income, output, Y


Stabilisation policies:Stabilisation policies:

Economic fluctuations are caused by shifts in Economic fluctuations are caused by shifts in ASAS or or AD.AD.

Exogenous Exogenous variations in these two curves are called a variations in these two curves are called a “shock” to the economy.“shock” to the economy.

Shock on the Shock on the ADAD curve is called curve is called Demand ShockDemand Shock

Shock on the Shock on the AS AS curve is called curve is called Supply ShockSupply Shock


Economists try to define Economists try to define stabilisation policiesstabilisation policies that that reduce the breadth of the fluctuations in the short reduce the breadth of the fluctuations in the short termterm

Production and Labour tend to fluctuate around their Production and Labour tend to fluctuate around their respective natural long-term rates – SO stabilisation respective natural long-term rates – SO stabilisation policies try to contain fluctuations as near as policies try to contain fluctuations as near as possible their natural levels.possible their natural levels.

Two types of shock: Two types of shock: Aggregate Supply ShockAggregate Supply Shock

Aggregate Demand ShockAggregate Demand Shock


Aggregate Supply Shock:Aggregate Supply Shock:

Example: Credit CardsExample: Credit Cards

Credit cards purchasing is easier than cash Credit cards purchasing is easier than cash purchasing – so the spread of credit card use reduces purchasing – so the spread of credit card use reduces the quantity of cash in the economy.the quantity of cash in the economy.

Less cash = increase velocity of circulationLess cash = increase velocity of circulation

If each individual holds less cash, the demand If each individual holds less cash, the demand perameter perameter k k decreases so decreases so VV (the velocity of (the velocity of circulation) increases because circulation) increases because V = V = 1/1/kk


IF: the money supply remains constantIF: the money supply remains constant

THEN: increase THEN: increase VV causes and increase in nominal cost causes and increase in nominal cost and a rightward shift of the aggregate demand and a rightward shift of the aggregate demand curve.curve.

In the short term, increase demand = increase In the short term, increase demand = increase production (demand driven) creating economic production (demand driven) creating economic expansion or BOOM.expansion or BOOM.

At “old” prices (the prices of the starting point), At “old” prices (the prices of the starting point), companies sell more product, hire more labour, companies sell more product, hire more labour, make employees work overtime and use systems and make employees work overtime and use systems and instruments more intensely.instruments more intensely.


Over time, higher aggregate demand pushes up Over time, higher aggregate demand pushes up salaries and prices.salaries and prices.

When prices go up, the demand for products decreases When prices go up, the demand for products decreases and the economy “slows”, tending to the natural and the economy “slows”, tending to the natural rate of production growth.rate of production growth.

During this transition to a higher price level, both During this transition to a higher price level, both production and the economy in general operate production and the economy in general operate above the natural level.above the natural level.


What can a central bank do to mitigate expansion and What can a central bank do to mitigate expansion and bring aggregate production back to its natural level?bring aggregate production back to its natural level?

It can reduce the money supply to balance the velocity It can reduce the money supply to balance the velocity of circulation and thus stabilising aggregate of circulation and thus stabilising aggregate demand.demand.

SO – a central bank can reduce or eliminate the effects SO – a central bank can reduce or eliminate the effects of a demand shock on production and employment of a demand shock on production and employment by consciously controlling the money supply.by consciously controlling the money supply.

MONETARISMMONETARISM


Aggregate supply shock:Aggregate supply shock:

Since shock to supply directly affects prices, supply Since shock to supply directly affects prices, supply shock may also be called “price shock”.shock may also be called “price shock”.

IF: a negative shock (crop failure, etc.) causes the IF: a negative shock (crop failure, etc.) causes the short term aggregate supply (STAS) to rise, short term aggregate supply (STAS) to rise,

THEN: the price level rises and production drops – THEN: the price level rises and production drops – creating a situation of creating a situation of

STAGFLATION (high prices with low production)STAGFLATION (high prices with low production)

The Balance of the Nation StateThe Balance of the Nation StateFacing a negative supply shock, economic policy makers who Facing a negative supply shock, economic policy makers who

wish to lever aggregate demand have a difficult choice:wish to lever aggregate demand have a difficult choice:

a)a) To maintain aggregate demand = production and To maintain aggregate demand = production and employment are below natural levels = recession. Prices employment are below natural levels = recession. Prices will drop, but it hurts investment and their is a great will drop, but it hurts investment and their is a great deal of cost associated.deal of cost associated.

b)b) To expand aggregate demand to bring the economy To expand aggregate demand to bring the economy quickly back to natural levels. If the increase in quickly back to natural levels. If the increase in aggregate demand coincides (in breadth) with the supply aggregate demand coincides (in breadth) with the supply shock, the short-term aggregate supply curve will shock, the short-term aggregate supply curve will immediately shift upwards.immediately shift upwards.

The negative side effect is that prices permanently remain The negative side effect is that prices permanently remain high. There is no way to act on aggregate demand and high. There is no way to act on aggregate demand and maintain both full employment and price stability.maintain both full employment and price stability.


The The stagflationstagflation of the 1970’s and the euphoria of the 1980’s of the 1970’s and the euphoria of the 1980’s

1972-1973 – OPEC coordinates a reduction in oil supply 1972-1973 – OPEC coordinates a reduction in oil supply causing a 100% increase in oil prices globally.causing a 100% increase in oil prices globally.

This price increase in crude oil caused stagflation in most This price increase in crude oil caused stagflation in most industrial countries, paritcularly between 1974-1976 and industrial countries, paritcularly between 1974-1976 and 1979-1981.1979-1981.

Political discord among OPEC countries brought about a Political discord among OPEC countries brought about a 44.5% drop in oil prices in 1986, causing a drop in the 44.5% drop in oil prices in 1986, causing a drop in the inflation rate and in the unemployment rateinflation rate and in the unemployment rate

Since then, changes in consumer behaviour and technological Since then, changes in consumer behaviour and technological progress have made economies less sensitive to oil shocks.progress have made economies less sensitive to oil shocks.

In the last 30 years, the quantity of oil per unit of real GDP In the last 30 years, the quantity of oil per unit of real GDP has dropped by 40%has dropped by 40%

The Goods MarketThe Goods Market

1936: Keynes published “The General Theory of 1936: Keynes published “The General Theory of Employment, Interest, and Money”:Employment, Interest, and Money”:

post 1929 depression. The low levels of AD caused post 1929 depression. The low levels of AD caused low incomes and high unemployment – challenging low incomes and high unemployment – challenging the idea that aggregate supply defined national the idea that aggregate supply defined national revenue.revenue.

This is a cultural problem: National revenue sees at This is a cultural problem: National revenue sees at its centre the balance sheet of national governments its centre the balance sheet of national governments and government estimates in increasingly refined and government estimates in increasingly refined versions of Adam Smith’s “The Wealth of Nations” versions of Adam Smith’s “The Wealth of Nations” (1760?) – developed to account for the balance of the (1760?) – developed to account for the balance of the British Empire.British Empire.

The Goods MarketThe Goods Market Today – general view is:Today – general view is:

In the long term, prices are flexible and AS determines In the long term, prices are flexible and AS determines the level of income.the level of income.

In the short term, prices are viscous and variations in In the short term, prices are viscous and variations in AD determine the level of income.AD determine the level of income.

The IS-LM model:The IS-LM model:

IS = Investment and SavingsIS = Investment and Savings

LM = Liqidity and MoneyLM = Liqidity and Money


The IS curve describes the goods marketThe IS curve describes the goods market

The LM curve describes the money marketThe LM curve describes the money market

Interest rates, which influence both investment and the Interest rates, which influence both investment and the demand for money relate these two curves.demand for money relate these two curves.

The IS curve is a graphic description of the relationship The IS curve is a graphic description of the relationship between interest rates and income level in the goods between interest rates and income level in the goods and services market.and services market.

The simple model for this is called The Keynesian CrossThe simple model for this is called The Keynesian Cross


The Keynesian Cross:The Keynesian Cross:

The total income produced by an economy in the short The total income produced by an economy in the short term is largely determined by the desire of term is largely determined by the desire of companies, the government, and individuals to companies, the government, and individuals to SPEND.SPEND.

The more products companies can sell, the more they The more products companies can sell, the more they need to produce, and therefore hire employees.need to produce, and therefore hire employees.

So, according to Keynes, periods of recession represent So, according to Keynes, periods of recession represent an inadequate total an inadequate total expenditureexpenditure..


There are two types of expenditure:There are two types of expenditure:

Actual expenditureActual expenditure and and

Planned expenditurePlanned expenditure

Actual expenditureActual expenditure is the sum of money that is the sum of money that individuals, companies and public administrations individuals, companies and public administrations spend to purchase goods and services. It is identical spend to purchase goods and services. It is identical to GDPto GDP

Planned expenditure Planned expenditure is the amount that these actors is the amount that these actors would likewould like to spend on goods and services. to spend on goods and services.


Why is there a difference between Why is there a difference between actual expenditureactual expenditure and and planned expenditureplanned expenditure??

Answer: unplanned investment in Answer: unplanned investment in surplussurplus

If companies do not manage to sell all of the units If companies do not manage to sell all of the units produced, their surplus automatically increases produced, their surplus automatically increases (back-stock)(back-stock)

Analogously, if sales exceed supply, surplus diminishes Analogously, if sales exceed supply, surplus diminishes automatically.automatically.

These automatic fluctuations count as investment These automatic fluctuations count as investment expenditure for companies, so actual expenditure expenditure for companies, so actual expenditure may be different from planned expendituremay be different from planned expenditure


Suppose: Suppose:

A closed economy with fixed interest rates:A closed economy with fixed interest rates:

Planned expenditure is the sum of consumption, Planned expenditure is the sum of consumption, planned investment, and public expenditure ORplanned investment, and public expenditure OR

E = C + I + GE = C + I + G

Introducing the consumption functionIntroducing the consumption function

C = C(Y-T) where disposable income (Y-T) [total income C = C(Y-T) where disposable income (Y-T) [total income minus taxes]minus taxes]


Assuming that planned investments, public Assuming that planned investments, public expenditures, and taxes are fixedexpenditures, and taxes are fixed

(I = I, G = G, and T = T)(I = I, G = G, and T = T)

We obtain E = C(Y – T) + I + G ORWe obtain E = C(Y – T) + I + G OR

¯ ¯¯

¯ ¯ ¯E

Income, Output, Y

1€

MPCMarginal Propensity of Consumption


Marginal Propensity of Consumption:Marginal Propensity of Consumption:

Indicates the increase in planned expenditure in Indicates the increase in planned expenditure in relation to an increase in income of 1€relation to an increase in income of 1€

The Balanced Economy:The Balanced Economy:

Keynes considered the economy to be in equilibrium Keynes considered the economy to be in equilibrium when – actual expenditure = planned expenditurewhen – actual expenditure = planned expenditure

Indicating that total demand is satisfied because GDP Indicating that total demand is satisfied because GDP = not only output, but also total income= not only output, but also total income

SO: Y = E in an equilibrium situation (planned SO: Y = E in an equilibrium situation (planned expenditure = GDP)expenditure = GDP)


How do economies reach equilibrium?How do economies reach equilibrium?

Surplus plays a key role. Since surpluses fluctuate, Surplus plays a key role. Since surpluses fluctuate, acting on volume of production, production acting on volume of production, production influences the levels of income and moves the influences the levels of income and moves the economy towards equilibrium.economy towards equilibrium.

Fiscal policy and the multiplyer: Public expenditureFiscal policy and the multiplyer: Public expenditure

Since public expenditure is part of planned Since public expenditure is part of planned expenditure, an increase in public expenditure expenditure, an increase in public expenditure increases the level of planned expenditure for each increases the level of planned expenditure for each level of incomelevel of income


If public expenditure increases by If public expenditure increases by ΔΔG, planned G, planned expenditure increases by expenditure increases by ΔΔG, moving equilibrium G, moving equilibrium from point A to point B. from point A to point B.

A

B

Income, Output, Y

E

∆G

E1 = Y1 E2 = Y2

AE PE

∆Y


Why does an increase in government expenditure Why does an increase in government expenditure (fiscal policy) amplify effects on the econonmy?(fiscal policy) amplify effects on the econonmy?

Given the consumption function: C = C(Y-T)Given the consumption function: C = C(Y-T)

increased income = increased consumptionincreased income = increased consumption

SO – increased govt. expenditure also increases SO – increased govt. expenditure also increases consumption – which increases income, and so on.consumption – which increases income, and so on.

So an increase in government expenditure increases So an increase in government expenditure increases consumption disproportionallyconsumption disproportionally


Fiscal policy and the multiplyer: taxesFiscal policy and the multiplyer: taxes

Lowering taxes (∆T) immediately Lowering taxes (∆T) immediately

increases income, increasing increases income, increasing

consumption by MPC x ∆T. So, for consumption by MPC x ∆T. So, for

every given level of income, plannedevery given level of income, planned

expenditure is higher.expenditure is higher.

So, like increase government expenditure, lowering So, like increase government expenditure, lowering taxes has an amplifying effect on the economy.taxes has an amplifying effect on the economy.


Interest rates: Interest rates:

The Keynesian Cross is only the first step in The Keynesian Cross is only the first step in understanding the IS –LM modelunderstanding the IS –LM model

The relationship between Investment and Interest The relationship between Investment and Interest rates is fundamental to this understandingrates is fundamental to this understanding

Investment (I) = Investment in relation to Interest Investment (I) = Investment in relation to Interest rates OR rates OR

I = I(r)I = I(r)

The Goods MarketThe Goods MarketE AE

PE

Income, Output, Y

∆I

Y2 Y1

Interest rate, r

Investment, I

Interest rate, r

Income, Output, Y

r1

r2

I(r1)I(r2)

1

2

3

4

5

r1

r2

Y2 Y1

IS

Note: an increase inpublic spending pushesthe PE curve up and moves the IS curve tothe right

The Money MarketThe Money Market

The LM curve illustrates the relationship between The LM curve illustrates the relationship between interest rates and income levels in real money interest rates and income levels in real money markets.markets.

To understand this, you must understand theTo understand this, you must understand the

THEORY OF PREFERENCE FOR LIQUIDITYTHEORY OF PREFERENCE FOR LIQUIDITY

Interest rates is adjusted to balance supply and Interest rates is adjusted to balance supply and demand for the most liquid component of the demand for the most liquid component of the economy: moneyeconomy: money

This theory forms the basis for the LM curveThis theory forms the basis for the LM curve

Note: Liquidity = the ability of an asset to be converted Note: Liquidity = the ability of an asset to be converted into cash quickly and without any price discountinto cash quickly and without any price discount


It is important to consider real money balances here:It is important to consider real money balances here:

SO the real money balance = SO the real money balance = the supply of money (M) / prices (P)the supply of money (M) / prices (P)

the Theory of Preference for Liquidity the Theory of Preference for Liquidity maintains that real money supplies aremaintains that real money supplies arefixedfixed

SO SO (M/P)° = M/P(M/P)° = M/P

The money supply is an exogenous variable because it The money supply is an exogenous variable because it is established by the central banks.is established by the central banks.

Prices are also exogenous because the IS-LM model is Prices are also exogenous because the IS-LM model is based on the short term, when prices are fixed.based on the short term, when prices are fixed.

¯ ¯


The previous hypotheses imply that the supply of real The previous hypotheses imply that the supply of real money balances is FIXED, and, specifically, does not money balances is FIXED, and, specifically, does not depend on interest rates – therefore, depend on interest rates – therefore,

The supply curve for real money balances is VERTICLEThe supply curve for real money balances is VERTICLE

The theory for preference of liquidity states that the The theory for preference of liquidity states that the interest rate (r) is one of the determinants of the interest rate (r) is one of the determinants of the amount of money that individuals decide to hold on amount of money that individuals decide to hold on to since:to since:

the interest rate represents the cost-benefit of keeping the interest rate represents the cost-benefit of keeping money: that which you must give up to keep a part money: that which you must give up to keep a part of your wealth in a liquid activity, such as money, of your wealth in a liquid activity, such as money, that holds no interest rate – as would be the case that holds no interest rate – as would be the case with shares, bonds, or other bank investments.with shares, bonds, or other bank investments.


When interest rates rise, there is incentive to keep less When interest rates rise, there is incentive to keep less cash money, so we can write:cash money, so we can write:

(M/P)(M/P)dd = L(r) where = L(r) where

(M/P)(M/P)dd = the demand for real money balances = the demand for real money balances

L(r) = the relationship between liquidity and interest L(r) = the relationship between liquidity and interest rates.rates.

This curve is negative because increased interest rates This curve is negative because increased interest rates correspond to a drop in demand for real money correspond to a drop in demand for real money balancesbalances


According to the theory of preference for liquidity, According to the theory of preference for liquidity, supply and demand for real money balances supply and demand for real money balances determine the prevailing interest rates in an determine the prevailing interest rates in an economy – SO economy – SO

interest rates vary so as to maintain balance in the interest rates vary so as to maintain balance in the money market.money market.

Equilibrium is found when:Equilibrium is found when:

Individuals try to adjust their portfolios, thus Individuals try to adjust their portfolios, thus influencing the interest rateinfluencing the interest rate


Equilibrium in the money market:Equilibrium in the money market:

If interest rates are operating higher than equilibrium If interest rates are operating higher than equilibrium levels:levels:

the supply of real money balances exceeds the the supply of real money balances exceeds the demanddemand

Individuals who hold extra money try to get rid of it, Individuals who hold extra money try to get rid of it, converting part of their non-earning activities converting part of their non-earning activities (money) into earning bank deposits or interest (money) into earning bank deposits or interest earning stocks and bondsearning stocks and bonds

Banks and interest paying institutions (who sell Banks and interest paying institutions (who sell stock and bonds) react to the increase in converted stock and bonds) react to the increase in converted wealth by lowering the interest rates they offer –wealth by lowering the interest rates they offer –

Bringing the money market back into equilibriumBringing the money market back into equilibrium


M/P Real Money Balances, M/P¯ ¯

Interest rate, r

Supply

Demand, L(r)

Equilibrium interest rate

What happens when the curve shifts to the left?

macro economics

Technology

nation state aggregate

nation state aggregate

quantity of aggregate

aggregate price level

aggregate demand drops

aggregate outputy

given supply of money

aggregate demand curve