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ECON-1007EL Study Guide - Final Guide: Output Gap, Nominal Interest Rate, Real Interest Rate


Department
Economics / Science Èconomique
Course Code
ECON-1007EL
Professor
Daviau Charles
Study Guide
Final

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MACROECONOMICS EXAM REVIEW
-Chapter 11 IMPORTANT - JUST KNOW HOW TO DO THE DIFFERENT GRAPHS AND HOW TO FIX THEM
!Expansionary Gap (p. 276/278)
!
! (Graph 1) !!!!!!!(Graph 2)
!
The difference between these two graphs is that the first one will take longer to reduce the expansionary
gap because there is no government involvement helping to speed up the process. In the second graph, the
expansionary gap is reduced much quicker since government spending is decreased and taxes and interest
rates are increased to slow the economy down.
Graph 1 - This shows an expansionary gap at point a (orange). This is because the actual output is greater
than the potential output, since the economy is producing more than the long run aggregated supply. It
shows that in the long run as time goes on, the short run aggregated supply will shift upwards to the
SRAS1 and return to the potential output that creates a stable economy however, will result in a higher
price. Shown at point b (green). This expansion gap is reduced automatically since it shows the automatic
elimination of output gaps
Graph 2 - This also shows an expansionary gap at point a (orange). By using macroeconomic policies by
decreasing government spending, increased taxes and interest rates the aggregated demand will shift left to
AD1 decreasing output while maintaining price level.
!Recessionary Gap (p.276/278)
LRAS
LRAS
Price Level
Price Level
Output
Output
SRAS
SRAS1
AD
Y
Y*
SRAS
Y*
Y
AD1
AD

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

! (Graph 1) !!!!!!!(Graph 2)
The difference between these two graphs is that the first one will take longer to reduce the recessionary
gap because there is no government involvement helping to speed up the process. In the second graph, the
recessionary gap is reduced much quicker since government spending is increased and taxes and interest
rates are decreased to speed up the economy.
Graph 1 - This shows an recessionary gap at point a (orange). This is because the actual output is less than
the potential output, since the economy is producing less than the long run aggregated supply. It shows
that in the long run as time goes on, the short run aggregated supply will shift downwards to the SRAS1
and return to the potential output that creates a stable economy however, will result in a lower price.
Shown at point b (green). This recessionary gap is reduced automatically since it shows the automatic
elimination of output gaps
Graph 2 - This also shows a recessionary gap at point a (orange). By using macroeconomic policies by
increasing government spending, decreased taxes and interest rates the aggregated demand will shift right
to AD1 increasing output while maintaining price level.
-BANK OF CANADA
-Its monetary policy objective is to keep inflation rate low
uses interest rates to achieve its monetary policy objective
controls nominal interest rates through its overnight rate target
-Interest rate (r) = nominal interest rate - inflation rate
-Higher real interest rate causes less spending
Implies more costly to borrow
Decrease household consumption
Decrease planned investment
LRAS
LRAS
Price Level
Price Level
Output
Output
SRAS1
SRAS
AD
SRAS
AD1
Y*
Y
Y*
Y

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

-Recessionary gap
BOC can reduce real interest rates
-Stimulating consumption and private sector investment
-Increasing PAE
-Increasing output and employment
-Expansionary gap
BOC can increase real interest rates
-Reducing consumption and private sector investment
-Decreasing PAE
-Decreasing output and employment
-TYPES OF MACROECONOMIC POLICY
Monetary policy
-Interest rate decisions (by bank of Canada)
Fiscal policy
-Decisions about the government budget. Eg. total level and growth of
Government spending
Government revenues
Direct - government spending up taxes down
Indirect - government spending down taxes up
-GDP & PLANNED AGGREGATED EXPENDITURE
Equation for GDP : Y = C + I + G + NX
-C = Consumption all goods and services
-I = Private Sector Investment
-G = Government Purchases
-NX = Net exports
3 Faces of GDP
-Production
-Expenditure
-Income
Real GDP
-Not influenced by inflation
-Measure physical volume of production (Actual)
Nominal GDP
-Measures dollar value of production (Current)
-Includes both inflation and real growth
Planned Aggregated Expenditure (PAE)
!PAE = C + Ip + G + NX * ALWAYS START SOLUTIONS WITH THIS EQUATION *
!PAE = C + mpc(Y - T) + I + G + NX
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