Macroeconomics Formulas: AD/AS

• Formulas provided include rate change, quantity theory of money, Taylor rule, and the simple deposit multiplier.
• The rate change formula is (point 2 – point 1)/point 1 *100.
• The quantity theory of money formula is: Money supply growth rate + velocity growth rate = GDP growth rate + price level growth rate.
• The Taylor Rule formula is: Inflation rate = equilibrium Federal Funds Rate + 0.5(inflation rate – Fed's target rate of inflation) + 0.5(output gap).
• The simple deposit multiplier formula is 1/rr (rr = required reserve ratio).

Aggregate Demand and Aggregate Supply

• The Aggregate Demand (AD) Curve illustrates the total demand for goods and services at different price levels.
• The AD Curve slopes downward due to the wealth effect, the interest rate effect, and the international trade effect.
• The wealth effect says higher prices reduce purchasing power, which leads to lower consumption.
• The interest rate effect says higher prices cause higher interest rates, which leads to lower investment.
• The international trade effect says higher domestic prices result in fewer exports, and more imports.
• A rightward shift in the AD curve (increase in AD) is caused by increased consumption, investment, government spending, and net exports.
• Increased consumption results from higher wealth and consumer confidence.
• Increased investment comes from lower interest rates and business optimism.
• Increased net exports are due to a weaker domestic currency and foreign demand.
• A leftward shift in the AD curve (decrease in AD) is caused by the opposite factors.
• The Short-Run Aggregate Supply (SRAS) Curve slopes upward because wages and input prices are sticky, meaning they adjust slowly.
• Firms increase output as prices rise, which results in higher profits.
• Shifts in SRAS are caused by input prices, productivity changes, and supply shocks.
• Input prices include wages and oil prices.
• Supply shocks include natural disasters and technology.
• The Long-Run Aggregate Supply (LRAS) Curve is vertical and independent of the price level.
• It represents full employment output, which is potential GDP.
• Short-run equilibrium occurs where AD = SRAS.
• Long-run equilibrium occurs where AD = SRAS = LRAS.
• A recessionary gap occurs when AD intersects SRAS to the left of LRAS.
• An inflationary gap occurs when AD intersects SRAS to the right of LRAS.

Dynamic AD-AS Model Assumptions

• Prices and wages adjust over time.
• LRAS grows due to technology, labor, and capital.
• AD shifts due to policy and expectations.

Money, Banking, and the Federal Reserve

• A barter system requires a double coincidence of wants, making it inefficient.
• A barter system lacks a common measure of value, which reduces productivity.

Functions of Money

• Money serves as a medium of exchange used to buy goods/services.
• Money serves as a unit of account to measure value (prices listed in money).
• Money serves as a store of value, holding value over time (savings).
• Money serves as a standard of deferred payment for loans/future payments.
• Trust in money is established because it is backed by the government (fiat money).
• Money is accepted as legal tender.
• Money should be stable in value, which is achieved through low inflation.
• M1 money supply includes the most liquid forms of money, such as cash and checking accounts.
• M2 money supply includes M1 plus savings accounts and small time deposits.
• Banks lend out deposits through fractional reserve banking.
• The money multiplier is 1 / reserve requirement.
• Total money created = initial deposit × money multiplier.
• The Federal Reserve (Fed) was created in 1913 to stabilize the banking system, control the money supply, and act as a lender of last resort.

Quantity Theory of Money

• The equation for the quantity theory of money is MV=PY.
• MV=PY means Money × Velocity = Price × Output.
• Inflation occurs if the money supply (M) grows faster than output (Y).
• Deflation occurs if M grows slower than Y.
• A stable economy occurs when M grows at the same rate as Y.

Monetary Policy

• Monetary policy involves the Fed's actions to influence the money supply and interest rates.
• The goals of the Fed are price stability (low inflation), maximum employment, and moderate long-term interest rates.
• The money demand curve is downward sloping: higher interest rates lead to lower demand for money due to the opportunity cost of holding cash.
• The money demand curve shifts right with higher GDP and higher price levels.
• The money supply curve is vertical and controlled by the Fed.
• The money supply curve shifts right with open market purchases and lower reserve requirements.

Fed's Monetary Policy Tools

• The Fed uses open market operations (buying/selling bonds).
• The Fed sets the discount rate (interest on loans to banks).
• The Fed uses reserve requirements (rarely used).
• The Fed pays interest on reserves (new tool).
• During a recession, AD shifts left.
• The Fed lowers interest rates to increase the money supply, causing AD to shift right.
• During inflation, AD shifts right.
• The Fed raises interest rates to decrease the money supply, causing AD to shift left.
• Unemployment is high in a recession and low in inflationary gaps.