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EC140 Lecture Notes - Lecture 15: Interest Rate, Aggregate Supply, Aggregate Demand

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School
WLU
Department
Economics
Course
EC140
Professor
Ken Jackson

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EC140 Full Course Notes
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EC140 Full Course Notes
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Document Summary

Lecture 15: money, interest rates and economic activity. As interest rates go up people choose to hold their money, they leave it in bonds so they can earn interest. Graphed in terms of interest rates (price) and the quantity of money. Monetary equilibrium when they intersect, therefore when they are equal. Changes in supply/demand for money affect the interest rate. Change in interest rate affects consumption and investment. Change in aggregate expenditure affect the ad curve. Changes in ad curve affects real gdp. Changes in the supply or in the demand for money cause the equilibrium interest rate to change. Money supply is shown by the vertical curve, ms. Demand for money is shown by the negatively sloped curve, md. Monetary equilibrium is at e0, with corresponding interest rate i0. Increase in the money supply causes ms to shift to the right creating a new equilibrium. When interest rate change the desired investment expenditure does not change, therefore fairly steep.

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Related Questions

Interpret the following graph showing the potential changes in supply of money compared to the demand for money. The demand for money is represented by line MD and the initial supply of money is represented by line MS. Then answer the questions below.

Change in Interest Rates

Find the new equilibrium points

1. If there is no change in the interest rates, where is the equilibrium point? What is the interest rate?

2. If there is a decrease in the supply of money, where is the new equilibrium point? What is the interest rate?

3. If there is an increase in the supply of money, where is the new equilibrium point? What is the interest rate?

Under the liquidity trap, money demand becomes very flat at low-interest rates. For this problem, consider the money demand function to be horizontal at a zero nominal interest rate.

A. Draw the LM curve. How does the slope of the curve change when the interest rate rises above zero?

B.Draw the IS curve. Does the shape of the curve change (necessarily) when the interest rate falls below zero?

C.Draw the AD curve? (Hint: From the IS-LM diagram, think about the price level at which the interest rate is zero. How does the AD curve look above this price level? How does the AD curve look below this price level?)

D.Draw the AD and AS curves and assume that equilibrium is at a point where output is below the natural level of output and where the interest rate is zero. Suppose the central bank increases the money supply. What will be the effects on output in the short run and the medium run? Explain in words.

Part 1

Evaluate whether each of the following statements is true or false. Explain your answer and provide a supporting rationale.

a.The short-run aggregate supply (SAS) curve slopes upward because households spend more as their incomes increase.

b.The long-run aggregate supply curve can never shift.

c.Either a decrease in the nominal money supply by the Federal Reserve, all else held constant or an increase in the price level, all else held constant, will shift the aggregate demand (AD) curve to the left.

d.The Keynesian portion of the short-run aggregate supply (SAS) curve would be relevant during a recessionary situation.

e.Stagflation occurs when the aggregate demand (AD) curve shifts out on the upward sloping portion of the short-run aggregate supply (SAS) curve.

Part 2

Evaluate whether each of the following statements is true or false. Explain your answer and provide a supporting rationale, using graphs to support your answer. You can create graphs by hand and take pictures and upload them with your answers, or you may use Word or Excel, and upload the file created by these software packages.

a.If the real money demand is greater than the real money supply, interest rates must rise to reach equilibrium in the money market as institutions sell bonds to obtain more money.

b.The federal government's control of the money supply, which influences interest rates, is the primary tool that policymakers use to impact the macroeconomy.

c.A decrease in the reserve requirement decreases the money supply because banks have fewer reserves.

d.The real money demand curve shows how households and businesses change their spending in response to changes in the interest rate.

e.Both an increase in the nominal money supply by the Federal Reserve and an increase in the price level will cause the real money supply curve to shift to the right.