ECON 302 Study Guide - Midterm Guide: Aggregate Supply, Money Supply, Aggregate Demand

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5 Feb 2016
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Money and Banking 302, Midterm Fall 2011
Question 1
In the manner of the Schools briefs (or drawing upon lecture or other sources) discuss and
explain the shape and slope of the:
Part 1 (8pts): Shape and slope of aggregate demand curve. See your Schoolbrief Defining
Demand. The aggregate demand curve is not a behavioural curve meaning you cannot
justify its downward sloping shape by saying that when prices go down people demand
more. It is much more complex than that. In you past micro class you may have seen that when
the price of a good say coconuts fall, you have an income (you feel richer so you buy more of a
normal good like coconuts) and substitution effect (your coconuts seem more appealing
compared to other goods like them so you buy more). Those 2 effects gave you a downward
sloping demand for coconut. The demand curve for coconuts is about the relative price of
coconut with other goods. IT IS NOT THE SAME OF YOUR AD CURVE. YOU CANNOT SAY
WHEN THE PRICE FALL PEOPLE WILL DEMAND MORE, LIKE YOU WOULD FOR
COCONUTS. THE AD CURVE IS AN EQUILIBRIUM LOCUS. Meaning the AD curve is a
collection of points of equilibrium in your money and goods markets (the equilibrium point of your
IS/LM curves intersection). Remember, the AD curve comes from moving the LM curve in your
IS/LM graph. When prices change, REAL money supply change and you have an LM curve
moving along your IS curve and giving you different intersection points related to different values
of Y. Taking all the equilibrium points and their value of Y and putting them in the P/Y graph, you
get the AD curve. The AD curve tells you when prices are higher, REAL money supply
decreases interest rates are higher, Cd and Id decrease and though a multiplier effect contained
in the IS curve, Y decreases. So the AD curve takes into account the money market clearing
"part" in the LM curve and the multiplier effect "part" (how much Y changes from a change in Cd
and Id) in the IS curve. As you can see it is much more subtle than for the coconuts scenario.
Part 2 (8pts): Shape and slope of your aggregate supply curve. See your Schoolbrief Defining
supply. Follow the reasoning in the section "let the prices rise."
Part 3 (3pts): How do monetary events affect the shape and/or position of each of these curves?
Here you needed to answer in terms of AD/AS curves not IS/LM. It was sufficient to answer by a
shift in AD.
Part 4 (8pts): In the manner of the Bob Dunn notes, discuss the shape and slope of the balance
of payments curve. Remember to discuss the shape and slope of the BOP curve in the case
where world currency and trade markets are closely integrated, as well as the case where such
markets are not well integrated.
Here I needed to understand that you knew what the BOP curve was about. Upward sloping
because when Y increases, imports increase, in order to stay on your BOP curve (when KA=CA
or BOP=0), you need to finance your imports (CA account) with a rise in r to attract capital (KA
account). The flatness/steepness of the slope has to do with capital integration and the marginal
propensity to import.
Part 5 (3pts). How does the BOP curve move (if it does move) when policy makers have the
power to change exchange rates?
When policy makers have the power to change exchange rates, your BOP curve will move (shift
right when depreciation or left when appreciation.) ***You should get used to the terms
appreciation/depreciation, it is less confusing than saying exchange rates increase or decrease.
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