ecs 102 Diagrams for Ecs102-8

Production

Spending Income

gggg

FIRMS

FACTORMARKET

HOUSEHOLDS

GOODSMARKET

GOODS A

ND SER

VICES

:

.

Pro

duce

/com

bine

FOP

to S

ELL

ON:

FOP:

BO

UGHT

FOP : OFFER FOR SALE

GOODSAND SERVICES

(SOLD TO)

DIAGRAMS FOR ECS102-8 (NOT GRAPHS)

CHAPTER 1:INTERDEPENDANCE OF THE MAJOR SECTORS MARKETS AND FLOWS IN A MIXED ECONOMY.

IN MIXED ECONOMY:

THE DIAGRAM: "The 3 Major Flows in the Economy" -Production –generates- Income(from various FOP only) –generates (used to(partly) spend on)- Spending-Buys/pays for Production

Circular flow of goods and Services in the Economy.

1

FIRMS

FACTORMARKET

HOUSEHOLDS

GOODS MARKET

SPENDING

INCOME

INCOME

WAGES/

PROFITSp

endi

ng

CIRCULAR FLOW OF INCOME DIAGRAM:

GOVERNMENT IN THE CIRCULAR FLOW OF INCOME AND SPENDING

2

FIRMS

HOUSEHOLDS

FINANCIAL SECTOR

jjjjjjjjjjjjjjjjjjjj

FIRMS

HOUSEHOLDS

FINANCIAL SECTORGovernment Foreign

Sector

C I

S

Z

C

X

G

C

T

The FOREIGN SECTOR IN THE CIRCULAR FLOW OF INCOME AND SPENDING.

Payment for imports (leakage) Firms Foreign sector spending and spending and income income Households payments for imports injection

Financial Institutions in the circular flow of income andspending.3.5t

saving Investment

. Spending and Income

Spending and Income

Saving

THE MAJOR ELEMENTS OF THE CIRCULAR FLOW OF INCOME AND SPENDING C,S,T,Z=LEAKAGES and I,G,X=INJECTIONS

3

4

(extra diagram): INTERACTION BETWEEN FIN.SECTOR +FOREIGN+GOVERNMENT IN THE CIRCULAR FLOW (MONETARY)

5

CHAPTER 3:

HORIZONTAL AXIS IS :'QTY. OF MONEY' ...VERTICAL IS 'INTEREST RATE'

Diagrams below:all 3 of incl .active +passive added =totalNote that the position of the curve is determined by the demand for active balances and the slope is determined by the demand for passive balances. The total demand for money is equal to the demand for active balances plus the demand for passive balances.  The demand for active balances is a positive function of the level of output and is represented as a vertical line (more) in the money market diagram.   The demand for passive balances is a negative function of the interest rate and is represented as a downward sloping line.

6

 The demand for active balances (La), which is independent of the level of the interest rate, is shown in (a) for a given level of real income.  The demand for passive balances (Lp), which is inversely related to the interest rate, is shown in (b).  The total demand for money (LL), which is a function of the level of real income and the interest rate, is given in (c). The total demand for money is obtained by adding the quantity of active balances (La) and the quantity of passive balances (Lp) at each interest rate.  

EQUILIBRIUM IN THE MONEY MARKET-Pg 371 textbook.

According to this approach, the money supply is determined by the interaction of the demand for money and the interest rate.  The interest rate in return is determined mainly by the monetary authorities. LL represents the demand for money curve which indicates the quantity of money demanded at various interest rate levels.   If the monetary authorities set the interest rate (for instance through accommodation policies) at i2 the quantity of money demand is L1.  Since the supply of money is determined by the demand for it, the money supply is  M1 which is equal to L1. At a lower interest rate of i1, both the quantity of money demanded and supplied increases to L2 and M2.  There is no independent money supply curve since the money supply depends on the demand for money and the cost of credit. Traditional Approach to EQUILIBRIUM IN THE MONEY MARKET-Pg 371 textbook.:

7

same diagram as above but two vertical M-M lines added(the supply of money which is supposed to be controled by the Gov.-If MM shifts right because gov incr.money supply-then interest rates will drop-see new equilibrium point-and visa versa-pg 372 textbook.

CHAPTER 4:THE PUBLIC SECTOR:

The Impact of a Specific Excise Tax:1) Two types of Excise Tax:

a) term Specific Excise Tax:Per unit:eg R4 on each beerb) term Ad Valorem tax:% of value eg 5%

2) Example:A specific Excise tax on cigarretes will have a burden on :a) company cannot pass full burden of tax over to consumer because it causes a

decrease in demand which causes the company to sell at prices lower than what it would like to.

b) Companies:less demand from high prices will cause a loss of {qty1*price1} –minus{qty2*price2)

c) Employees:less sales=less employees needed or must accept lower wages(can also shift supply right again cause cheaper to make smokes+can sell cheaper then=more demand new 'E')

d) Customers loose:must pay more for cigarettes.

Example: Effect of a Specific Excise Tax on Cigarettes:Burden -1-Consumer/ -2Company/-3-Employees

The supply curve ss will shift to left(per qty. higher price).:causing all 3 parties to bear burden of excise tax.(see number /point 2 above)

8

CHAPTER 5

1-SEE PAGE 426 T FOR THE IMPACT OF A SPECIFIC IMPORT TARIFF:

remember: to add point 1- more revenue for gov. 2- strengthen balance of payments-less imports+ other factors which could render overall decision uncertain.

2- THE EQUILIBRIUM EXCHANGE RATE:The Rand-Dollar exchange Rate Shifts+Movements.

----if just the price above e = excess supply of $ then–if price changeMOVEMENTon both curve ----if just the price below e = excess demand of $ then –if price changeMOVEMENTon both curve

Change Graph change RAND DOLLARDemand for Qty $ increases(at each price) Demand curve SHIFT right Depreciates AppreciatesSupply of Qty $ Increases (at each price) Supply curve SHIFT right Appreciates Depreciates

9

Demand for Qty Dollars falls(at each price) Demand SHIFT left Depreciates AppreciatesSupply of Qty $ falls(at each price) Supply SHIFT left Appreciates Depreciates

Table of effect on domestic prices and current account and export/import from Rand/Dollar Appreciation/Depreciation.ChangeinR$ exchange rate Export prices

in $Import prices R

Current account

Domestic prices

rand depreciate decrease increase improves riserand appreciate Increase decrease worsens fall

CHAPTER 7

:KEYNESIAN MODELS excluding GOVERNMENT AND THE FOREIGN SECTOR.

GRAPH OF The consumption function.:SHOWS ALL 3 CHARACTERISTICS The Line C is called :the Consumption function C-BAR is the autonomous consumption.Bar above C indicates it

isautonomous/independant fromY

(1)SHOWS you get a CONSUMPTION INCREASE FOR INCOME INCREASE.Note:Put dotted lines and p1/P2 c1/C2to show a change in C(consumption) .. versus a change in Y(income,production or output).Because C changes less than Y it shows some increase in income is usually saved ,not all is spent

(2)SHOWS term Automomous Consumptionif income = 0 still have a consumption is If Income = 0 then the intercept Cbar- (with bar on top-autonomous Y) is the spending /consumption independant of Y-Income.(eg savings or credit)Regarded as a MINIMUM level of consumption.

(3)SHOWS term Induced Consumption is shown by the slopeC. Because C changes less

than Y it shows some increase in income is usually saved ,not all is spent .

10

term Marginal Propensity to Consume:= "c"=change Y(income) over change C (consumption) Shows the proportion of EXTRA income that will be used for Consumption ratio

between change in consumption and change in income-one of most important ratios in macroeconomics.It is equal to the Slope of the consumption function curve.Lies between 0<c<1 because Y cannot larger C.

GRAPH OF AUTONOMOUS AND INDUCED CONSUMPTION. 3 points needed: 1- that ^ C is smaller than ^ y( that is where mpc comes into it) 2-And that 'induced' is from change in Y only,not from autonomous or others that induced comes from the cY part of equation just show : 1-a box shaded for the autonomous consumption from C intercept to right and

explain. 2-the triangle below curveand above box for induced consumption. 3-The equation of the curve:=C=Cbar +cY 4-the slope by a triangle /box with 'c' as slope and' 1 ' at bottom SEE page 465 fig 18.2

CHAPTER 7

:KEYNESIAN MODELS INCLUDING GOVERNMENT AND THE FOREIGN SECTOR.

1-Government Spending:(G)

Government Spending VS Income: G vs I1) During 70-90' Gov spending increased-

housing,defence,education,health,safety &security.

11

2) term Gov.Spending is a Political Issue-causes SHIFT in curve and thus is Autonomous to Income(Y):Thus G=G bar (ie:autonomous.)

3) horizontal line,independant ,political issue,autonomous,upward shift,vertical intercept.4) Summary:addition of (G )

a) raises level of Aggregate Spendingb) leaves multiplier unchangedc) raise equilibrium level income Y0 cet.par.

Gov.Spending added to (A)Total Spending VS Income: A vs I 1) Adding go vernment spending G, which is independent

of Y, causes an upward shift, equal to G, of the aggregate spending curve.  The equilibrium level of income increases from Y1 to Y2. 

2) Government spending is part of aggregate spending (A = C + I + G) and has a direct impact on the equilibrium level of income and output. 

3) Government spending G is the purchasing of goods and services by the government and is an instrument of fiscal policy that can be used to influence the level of output and income in the economy.

4)  The aggregate spending function without government spending is:  A = C + I = A + cY.    Autonomous spending is  A = C + I and is represented by the vertical intercept A

Gov. Spending influences the multiplier effect.

1) The addition of G will increase income(Y) by G * Multiplier2) To calc: EQUILIBRIUM CONDITION: we start with3) Y=A(where eqilibrium is)4) so :Y=C+I+G because (A=C+Ibar+Gbar)5) So: Y=(Cbar+cY)+I+G

6) Thus:to solve above equation: 7) Y-cY=Cbar+Ibar+Gbar 8) so:Y(1-c)=Cbar+Ibar+Gbar 9) THUS: Y 0=1/1-c(Cbar+Ibar +Gbar)

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10) General formula can still be written: Y0=#@# (Abar) 11) Where Y0 is equilibrium of A and Y12) .Where:#@#=multiplier , Abar = total autonomous spending13) Gov. Spending is a powerful tool to raise level of production and income

and increase employment. However addition of prices,wages ,interest rates and the foreign sector makes tool less powerful from other influences.

2-Taxes(T)1) To Spend Gov. must levy taxes.2) Taxes are a Leakage and Gov.Spending is an injection into circular flow of goods and

services in the economy.3) term Disposable Income :(or after tax income)-taxes reduce disposable income-and

reduce 'C'4) term Direct/Indirect Influence- Income &Spending:Taxes reduce C

indirect,spending=Sdirect5) personal income Tax and Vat are the 2 most important Max sources of tax in rsa for gov.6) term A Proportional tax rate for the entire economy per year is realistic-Only

Progressive/regressive per bracket.7) term extrogenous variable :Tax rate is politicly determined ,also tax REVENUE

=extrogenous.

1) Graphicly the introduction of a tax rate SWIVELS the CURVE downward,or upward for a lesser tax rate.

2) In the simple Keynesian model taxes T are a certain proportion t of income Y.  The proportion is called the tax rate t.  The slope of the curve is determined by the tax rate

Disposable income/Tax Calculation for Formula.a) term Tax Rate: T=tY (where t=tax rate%-proportional !!!!!)******b) Yd =Y-T (Disposable income = Tot. Income –Tot. Tax subtracted)********c) So: Yd=Y-tY (because T=tY)d) So: Yd=Y(1-t) *******e) NOW WE MUST MODIFY 'Consumption function' to leave out taxed part of Y- so for

disposable income :C=Cbar +cYd (Y(d) is disposable income)*********f) So: C=Cbar +cYd

g) so:C=Cbar+c(Y-Yt) (because Yd=Y-tY from point(c)above)

13

h) so:C=Cbar+c(1-t)Y ***** i) term:The new marginal propensity to consume is c(1-t) with taxes included.j) term The slope of this curve is c(1-t) which is allways smaller than c,slope was "c"

originally without introduction of taxes.

Multiplier with Taxes:

1) Multiplier without Taxes= #@#= 1/1-c2) Multiplier with Taxes = #@#=1/1-c(1-t) (Tax Reduces size of Multiplier through

reducing size of Marginal Propensity to Consume.)

3) Graph Consumption function or & Aggregate Spending function 'SWIVELS' downwards from extra tax/gets flatter.,or up from less

4) The introduction of a proportional tax thus:a) LEAVES AUTONOMOUS spending unchanged.b) REDUCES THE MULTIPLIER #@# c) REDUCES THE EQUILIBRIUM LEVEL OF INCOME Y0, Cet.Par.

The Equilibrium level of Income in an Economy with a Government Sector.1) increases the level of Vertical Intercept :All the

completely Autonomous spending: from Abar = Cbar + Ibar to Abar = Cbar + Ibar + Gbar

2) The original aggregate spending curve without a government sector is indicated by A1 with an equilibrium income of Y1.  With the introduction of government spending, the aggregate spending curve shifts parallel upwards to A2.  With the introduction of a proportional income tax, the aggregate spending curve becomes flatter, as indicated by A3.  The eventual equilibrium level of income is indicated by Y3.

Formulas: for sub-heading:1) from A = C + I to A = C + I + G.2) Y=A (equil. condition)3) A=C+ Ibar+Gbar (aggregate spending)4) C=Cbar +c(1-t)Y (consumption function)

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5) SUBSTITUTING:a) Y=Ab) Y=C+Ibar +Gbarc) Y=(Cbar +cYd)+Ibar+Gbard) Y=(Cbar +c(1-t)Y))+Ibar+Gbare) Y-c(1-t)Y=Cbar =Ibar+Gbarf) Y=(1-c(1-t))=Cbar +Ibar +Gbarg) Y0=1 /1-c(1-t) *****(Cbar+Ibar+Gbar).h) The equilibrium level of income can also allways be obtained by : #@# multiplied by

Abar (P.S. Abar is also vertical intercept or Autonomous spending.)6) term Induced Consumption= induced by an increase in income :induced to spend so

much more.

Fiscal Policy:Yf=(Y full)= Income equilibrium level at which full employment is reached.1) term FISCAL POLICY : We must consider how determinants(G)Gov. spending &

(T)Taxes can be used as policy instruments to influence important economic variables such as (Y) =Income or Production : T & G are main ingredients of BUDGET and main instruments of FISCAL POLICY.

2) The Gov. can Increase /Decrease Equilibrium level of Income or Production. BY:a) Direct:Increase /Decrease Gov.Spending and multiplier will effect large change.b) Indirect:Increase /decrease taxes and raising induced consumption spending and

multiplier.3) The formula for How much Gov.must spend to make a certain change=

a) ....^ Y =@ ^ G (like prev.example but now with 'G':^Y=@^I)(where ^='change'and @=#@#)

b) so:^G=^Y/@ --work out from there...4) Specific exercise:If the Gov. wishes to close the gap between full employment (=Yf as

an example) and lower levels by incresing spending –they must work pout how much with above formula.=^Y=@^G :so:^G=^Y/@. where multiplier will increase %income morethan %spending.

5)

1) The Formula is : formula.=^Y=@^G :so:^G=^Y/@.2) The level of full employment is presented by the YF line. 

The economy is in equilibrium at point E1 which is point of less than full employment and unemployment is experienced

3) Using fiscal  policy, that is the use of government spending G and taxes T, it is possible to increase aggregate demand in order to reach full employment.

4) An increase in government spending increases autonomous spending and via the multiplier it increases aggregate demand and the level of output.  In the diagram the aggregate demand curve shifts upwards and a new equilibrium is reached at the level of full employment.

5)

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2 -Introducing The foreign Sector into the Model:The Open Economy.

Introduction:1) Matters kept simple by assume X&Z are autonomous(unaffected by change in Income)

2) The change in Imports (Z) Exports (X)

a) level aggregate spending:A

will affect positively (+)

b) multiplier :@

Will NOT affect this

c) Equilibrium level income : Y

Will affect by multiplier effect+

Exports &Imports:1) Exports &Imports Autonomous to INCOME(Y)=horizontal line=expressed

X=Xbar /or/Z=Zbar2) BUT imports can be induced-ie they can be affected by (Y)income3) The positive relation between imports and economic activity in sa is one of stongest

macroeconomic relationships in the country. 4) EXPORTS are an Injection into economy & IMPORTS are a leakage.5) The Formula for Imports/Exports is: A +C + Ibar+Gbar+(Xbar –Zbar)6) term Net Exports usually referred to as =(X-Z)Graphs of the horizontal line of import/export function against tot.income or production.

7) If Net IMPORTS greater-Net Spending/demand less(from multiplier local re-spending)/////

if Net Exports greater net Spending more. (THIS IS TOPSY TURVY----WATCH OUT HERE ALL VISA VERSA)

8) --Multiplier * Net exports-- give change in income equilibrium for any one spot calculation-either-or+

Formulas for expots/imports.1) Net Exports usually referred to as =(X-Z)2) from A = C + I to A = C + I + G.+(X-Z)3) Y=A (equil. condition)4) A=C+ Ibar+Gbar +(Xbar-Zbar) (aggregate spending)5) C=Cbar +c(1-t)Y (consumption function)6) SUBSTITUTING:

a) Y=A

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b) Y=C+Ibar +Gbar+(Xbar-Zbar)c) Y=(Cbar +cYd)+Ibar+Gbar+(Xbar-Zbar)d) Y=(Cbar +c(1-t)Y))+Ibar+Gbar+(Xbar-Zbar)e) Y-c(1-t)Y=(Cbar +Ibar+Gbar+(Xbar-Zbar))f) Y=(1-c(1-t)) *(Cbar +Ibar +Gbar+(Xbar-Zbar))g) Y0=1 /1-c(1-t) *****(Cbar+Ibar+Gbar+(Xbar-Zbar))

1) In diagram a the autonomous net export function is given.  In diagram b the impact of autonomous net exports on aggregate spending and equilibrium income will be illustrated

2) In diagram b the aggregate spending curve A0 represents aggregate spending C + I + G and the corresponding equilibrium level of income Y0 without a foreign sector.

3) When the foreign sector is added, the vertical intercept changes.

4) If net exports are negative, as indicated by(X-Z)1, autonomous aggregate spending A declines and the aggregate spending curve shifts downwards and the equilibrium level of income decreases

5) It can also be visa versa depending on which way 'Net exports' leans to positive or negative.

Fiscal Policy inthe Open Economy: Once understnd imports not Autonomous-Gov.spending gets less powerful.(&multiplier

gets smaller.) Also-bal . of payments account:expansionary fiscal policy should raise income and

imports and reduce net exports.This can adversely affect current account. 'Net exports'(inp-exp) is basicaly the Current Account in Gov. accounts.

17

ECONOMICS part 2 Yr1

CHAPTER 8

: MORE ON MACROECONOMIC THEORY AND POLICY

The Aggregate Demand Aggregate Supply Model 8.1sp511t

1. REMEMBER ALL GRAPHS HEADINGS FOR AXIS's ARE ONLY:TOTAL PRODUCTION/INCOME AND TOTAL PRICE LEVEL and (ie MACRO economic=!!!!!!TOTAL!!!!! NOT MICRO) all Curves MUST be Labeled :AS0-AS0 ////AS1-AS1 and AD1-AD1 etc(NOT S1-S1 or D1-D1!!!!!!!!!!!)

2. .When you go further than "Keynesian models" you must include:Interest(monetary sector),Wages +variable prices. THEN the most popular model today for this is the :AdAs model.

3. "Ad-As"=Aggregate demand & Aggregate Supply models.=Macroecon.-NOT Microecon.---Demand /Supply curves4. AdAs-deals with:

a. General level of PRICES : eg From :C.P.I. ----NOT single goods pricesb. Total Prod. goods& serviceseg:From :GDP.-----NOT single goods production

5. BUT Macroeconomy cannot just be seen as SuM of all Micro-econ. part,dosnt work.6. Production still assumed =Income same as keynesian model. but prices =spending here

lDifferences Keynesian Differences AdAs model Implications for AdAsPrices given Prices Variable can study inflationWages given Wages Variable supply can change separate to

demand-wage change impact on production,income ,employment/unempl. ,&inflation be

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studied interest rates &money supply Given Interest rates Variable +money

supply can changecan used study monetary sector &monetary policy

Spending (/-Demand) is driving Force determines economic activity

level econ. activity determined by Demand +Supply

Changes from supply side can are also taken into account(maybe prices low or no raw materials available)

Production is only Nominal because price level cannot change-any spending + means prod +,(eg :not maybe prod less because price maybe also less )

production is REAL production PY =nominal productionP= REAL production

7. This is Law of demand&supply:Price Increase= Demand DOWN &Supply UP and Visa Versa8. NON-PRICE DETERMINANTS= cause Shifts in curves//PRICE Determinants causes Movements on

THE DIAGRAM OF ADAS CURVE:.9. The AD-AS model is the most popular model in macroeconomics. 10. The aggregate demand curve (AD) slopes downwards from left to right, indicating an

inverse relationship between price level /and total  expenditure (or aggregate demand). (more)

11. The aggregate supply curve (AS) is primarily governed by the cost of production and  normally slopes upwards from left to right. (more)

The Aggregate Demand Curve.1. Determined by anything that influences Aggregate spending in economy:

a. Same as in Keynesian model:BY:i (=interest rate)+C,I,G,T,X,Z (householdconsumptionetc)

b. Also by anything that influences these factors.i. (i)=interest rate

ii. (C) =Household consumptioniii. (I)= Investmentiv. (G)v. (T)vi. (X)vii. (Z)

2. MOST IMPORTANT factor =(i)= interest rate :influences (C)consumption &(I)investment spending3. NON-PRICE DETERMINANTS= cause Shifts in curves//PRICE Determinants causes Movements on4. FISCAL POLICY=

a. Taxes +b. Gov. Spending

5. MONETARY POLICY=Interest rates6. Contractionary Gov. Policy = A Demand curve SHIFT LEFT (less D for any one price)7. Expansionary =Gov. Policy= A Demand curve SHIFT RIGHT(more D for any one price)

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Change in non-price factors Shift of the AD curve

PRICE CHANGES Movement on curve

EXPANSIONARY POLICY Shift Right/Upward

CONTRACTIONARY POLICY Shift Left/Downward

Autonomous consumption C increases R

Investment spending I increases R

Government spending G increases R

Taxes T decrease R

Interest rate i decreases (which causes an increase in investment spending)

R

Net exports (X-Z) increase R

Autonomous consumption C decreases L

Investment spending I decreases L

Government spending G decreases L

Taxes T increase L

Interest rate i increases (which causes a decrease in investment spending)

L

Net exports (X-Z) decrease Shift Left

Changes in Aggregate Demand:1. 3 different types of slopes of Supply curve cause;

a. In recession:= where Aggregate SUPPLY curve is very Flat=+ demand causes +production but same PRICE,

b. In Very good times= of Full Employment +demand causes same (or little) production but –PRICE(production cannot expand=full capacity)

c. In medium times =normal sloping supply curve BUT THE PROBLEM is;i. + Increase in Demand: will cause a +in production (and + Employment) +increase in price

(and + Inflation)ii. – Decrease in Demand: will cause the opposite.

2. Thus if Gov. tries a contractionary policy-cause unemployment///BUT if Gov. tries Expansionary policy-cause inflation +price increase.

a. THUS gov. must choose which is worst-unemployment or price/inflation to make a choice.3. term Demand Management: the management of 'demand' by the Gov. using Monetary and Fiscal policy. 4. term Trade off:the Government plays with DEMAND by using : (i) / (G) / (T) . by using Monetary & Fiscal policy:

trade off between Demand + or – for Gov .Either price /inflation UP & Employment UP OR price/inflation DOWN & EmploymentDown

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The Aggregate Supply Curve1. Supply Curve primarily Governed by COSTS of PRODUCTION=Price FOP +Productivity2. The AS curve derived for given set factor prices (rent, wages and salaries, interest  and profit) and prices of

imported capital and intermediate goods, and for a given level of productivity,change in any of these factors causes shift of the AS curve

3. Supply Curve NOT usually affected by Expansionary +Contractionary Policies of Gov or the SUPPLY curve.(exept for interest rate does affect costs of production.)

4. PRICE factors cause : MOVEMENT on SUPPLY CURVE5. NON-PRICE factors cause :SHIFT of SUPPLY CURVE.

Changes Shift of the AS curve

Prices of factors of production increase left(or Upward)

Prices of imported capital and intermediate goods (eg OIL) increase

L

Productivity decreases L

Weather conditions deteriorate L

Prices of factors of production decrease R(or Downward)

Prices of imported capital and intermediate goods(eg OIL) decrease

R

Productivity increases R

Weather conditions improve R

The Slope of the Aggregate Supply Curve:1. keynes not concerned about Inflation when consider fix Great Depression –because curve flat at beginning –can

have NO PRICE INCREASE for MUCH production increase in supply curve. 2. The AS curve can also be depicted as having a flat part, a rising part and a vertical part.  

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The level of full employment( of all FOP) is represented by YF.,Y1 = point to which no price increase/prod.incr. The flat part AS curve represents economic conditions that very depressed –there is a substantial excess production capacity.  This implies that production can be expanded without putting significant pressure on the price level.   In other words, expanding production from the origin to Y1 does not require an increase in the price level.The rising part of the AS curve indicates that there is little or no excess capacity in the economy, that is when most factors of production are almost fully employed.  In this part of the curve, an increase in production is associated with an increase in the price level.   The vertical part of the AS curve indicates that full employment has been reached and production cannot be expanded beyond this level.

Changes in Aggregate Supply1. term:Stagflation: Stagnation +Inflation :{{{{ Stagflation occurs when an increase in the cost of production not

only results in higher prices but also in lower production, income and employment and higher unemployment.  This was a term coined in the 1970s for the twin economic problems of stagnation and inflation}}} From an upward SHIFT in Supply curve specificly due to :is caused by any increase in production costs of TOTAL PRODUCT ie GDP etc. eg:{price of oil/other inputs/etc} or {wages without corresponding production increase},or {profit margins}---causes (1) LESS Employment,(2) LESS Production =STAGNATION and HIGHER PRICES = INFLATION.

2.3. term :Supply Shocks:Where A SUPPLY curve SHIFTS UPWARD:ie could cause stagflation—presents Gov. difficult

decision—If expansionary Policy used to increase Demand to in turn increase employment(stop stagnation part of stagflation)-then Inflation will go even more up because higher demand curve SHIFT Up =Higher Equilibrium.BUT if Contractionary policy is used then opposite (eg oil crisis of 73's-expan.=worst since 50's war korea inflation //then of 79's –contr.-worst unemp. =recession since ww2) SOLUTION= TO: lower wages+production costs ,including an Anti-inflationary "INCOMES POLICY"(very difficult-keep wages growth balanced with productivity growth.)-this will cause OPPOSSITE SHIFT(right /downward) of Supply curve.

THE MONETARY TRANSMISSION MECHANISM DIAGRAMS (3 OF) From Diagram 1 TOP LEFT- It goes to diagram 2 bottom=KEYNES Method and also to Diagram 2 bottom

right =AdAs Method.

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A change in the interest rate leads to a change in investment spending, which in return causes a change in aggregate spending (demand) and consequently total production and income change.

The impact a change in the interest rate has on the level of output, will depend on the kind of model that is used.

1. Diagram top left illustrates a change in investment spending due to a change in interest rates.FROM THIS DIAGRAM WE GO TO EITHER ONE OR BOTH OF THE OTHER Following two:

2. In the simple Keynesian model, where prices and wages are given, it has the full multiplier effect; ie {:#@# * ^I = change in Y }( change in (i)- causes change in (I) - causes change in (A) - causes change in (Y) or in words :a change in interest rates causes a..^.in Investment causes a.. ^..Aggregate Spending causes..^.in Aggregate Income/ or Production.

3. In the AD-AS model, where prices and wages are flexible,  the multiplier effect is smaller because part of change in production/income is here taken up by a change in Price.Here in Symbols which we must know how to write out: ^ i –(arrow)-^ I--^A--^ AD--^Y and-- ^P or in words :a change in interest rates causes a ^ in Investment spending AND a ^ in Aggregate spending which both then causes a^ in Aggregate Demand causes a ^ in Both (1) Production / Income and (2)a change in Prices.(split in P or Y depends on Slope of demand curve)

EXEPTIONS TO THE RULE:1. If investment demand curve(Diag.1 ) is ---vertical,or completely inelastic---then it will not affect the Investment

spending or any of the rest at all.2. If the slope of Demand curve is flatter-more effect will happen to QTY than to PRICE thus a Expansionary policy

will have more effect on stimulating economy(not inflation) BUT:Steeper=Contractionary more effective-more Price/(inflation down quick) less QTY/Jobs-

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chapter 9The Causes of Inflation:

Demand- Pull and Cost-Push inflation.1. Difficult distinguish between the two-become intertwined in inflation process.2. Both cannot :

a. ignores possible linkages between the Aggregate Demand&Supply b. Only explain price level-not process of inflation.

Demand-Pull Inflation.1. When aggregate(macroeconomics)-demand UP but Aggregate supply remains unchanged-prices go up.-'too much

money chasing too few goods"-Causes prices to go up.2. Can be caused by any of components of AGGregate Demand:

a. (C)-consumption spending-lower interest rates(cheaper credit)b. (I)investment sending-eg from lower interest rates,or better business sentiment.c. (G)Government spending-eg provide better services to population,or to combat unemployment.d. (X)export earnings- higher earnings cause more spending by earners.

3. MONEY SUPPLY increase :Allways accompanied by increase in money supply.-allways related to increases in aggregate demand components.

4. Restrictive Monetary and Fiscal policies by Gov. used to keep Demand-Pull inflation in check.: Can cause Unemployment-decreased Production,decreased,income

a. MONETARY:Higher interest rates to make credit more expensive,& reduce availability of credit to various sectors(I)/(C) of the economy.-left Shift+

b. FISCAL:reduce Gov. spending,and /or increase taxation.-cause leftward shift

5. Illustrated by AdAs model. :increase in aggregate demand cause a shift to right of demand curve. Further increases in aggregate demand shift the AD curve to the right, for instance to AD4.  At an equilibrium point of E4, the price level is higher but the level of output is still at the level of full employment YF.  Increases in aggregate demand beyond the level of full employment can only lead to price increases because prod.cannot increase=Yf (full employment of FOP).

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Cost–Push Inflation:

3. IF production costs increase-

a. then Supply Curve Shifts to left from higher prices at each Qty.supplied. b. 'E'quilibrium goes up-Prices UP & Production&Income down.(+unemployment)

4. Stagflation:Stagnation in: production/income and Inflation from: higher prices.5. Cost–push inflation caused by:

a. Wages increase-(60% of cost of GDP)b. Cost of imported Capital & Intermediate goods (eg Oil,) from currency depr. or price incrc. Increase in Profit margins.d. Decreased productivity.e. Natural Disasters.

6. Measures To take to reduce this:a. CANNOT be Combated by restrictive Fiscal & Monetary policy's.b. incomes policy=to keep wages low

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chapter 10

Unemployment in the Keynesian & AD-AS Models.1. Both graphs assume that Level of Production IS positively related to Employment .2. Law of Diminishing Returns:can cause increase in production to only help to a

point in unemployment –because as employment increases so production increases ,but at a diminishing rate,until it goes backwards.

3. Slope of production function is = marginal product of labour =thus declines as employment increases.

a. Why production increase (Y!!) (!! ie:called Economic Growth here too !!) alone is a neccessary but insufficient condition for reducing unemplmnt.: Structural and Frictional & Seasonal lags cannot be done away with by increasing prod.

i. Frictional unemploymentii. new entrants: to market may be too many -be more than the rate of incr.

in Prod.iii. Skills- if workers Not have needed skills may still unemploy even in

economic growth.iv. Struct. – lack of skills TYPE cannot be overcome by just incr. productionv. Capital goods/Technology type increase in production increase emplmnt.

For GRAPH BELOW:Yf= production/income at FULL EMPLOYMENT Nf= employment at FULL EMPLOYMENT the curve of the production function shows the law of diminishing returns: the rate . of increasing returns from more people employed will slowly decrease as more are . ... employed.

If an increase in in the level of output from Y1 to Y2  is accompanied by an increase in capital intensive production methods the following occurs: The production function shifts upwards.  At each level of output less labour is required than before.To produce a level of output of Y2,  N1 number of workers are required and the level of unemployment is unchanged.In this case jobless growth has occurred. 

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CHAPTER 11

e Business cycle: The long term trend in economic activity ,(albeit growth or level) is broken up by

short term swings up & down called: upswings(expansion)(booms) and downswings(contraction)(recession) .

A business cycle has 4 'elements': trough,upswing,peak,downswing, A business cycle always starts on a trough And nds on a trough.

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