Chapter 13 - Chapter 13 I. Introduction a. Recall that...

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Chapter 13 I. Introduction a. Recall that inflation- an increase in the overall price level- is one of the key concerns of macroeconomists and government policy makers II. The Aggregate Demand Curve a. People’s demand for money depends on income, the interest rate, and the price level. b. In general, the amount of money required to make a given number of transactions depends directly and proportionately on the average price of those transactions c. As prices and wages rise, households will want to keep more money in their wallets and in their checking accounts; firms will need more in their cash drawers, and so forth. d. *Money demand is a function of 3 variables: interest rate, the level of real income, and the price level. Money demand will increase if the real level of output increases, the price level increases, or the interest rate declines. e. Deriving the Aggregate Demand curve i. Aggregate demand - the total demand for goods and services in the economy. ii. To derive the aggregate demand curve, we examine what happens to aggregate output when the price level changes iii. The aggregate demand curve is derived by assuming the fiscal policy variables and the monetary policy variable remain unchanged. In other words, the assumption is that government does not take any action to affect the economy in response to changes in the price level. iv. An increase in the price level increases the demand for money and shifts the money demand curve to the right v. Because of the higher price level, households and firms need to hold larger money balances than before. However, the quantity of money supplied remains the same. vi. With the interest rates now higher, fewer investment projects are desirable and planned investment spending falls. Lower I means planned aggregate expenditure is lower as a downward shift of the AE curve. Lower AE means inventories are greater than planned, firms cut back on output, and Y falls. vii. *An increase in the price level causes the level of aggregate output to fall.
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viii.The situation is reversed when the price level declines. A lower price level causes money demand to fall, which leads to a lower interest rate. A lower interest rate stimulates planned investment spending, increasing planned aggregate expenditure, which leads to an increase in Y. ix. *A decrease in the price level causes the level of aggregate output to rise. x. Aggregate Demand curve - a curve that shows the negative relationship between aggregate output and the price level. Each point on the AD curve is a point at which both the goods market and the money market are in equilibrium. xi. *Each pair of values of P and Y on the aggregate demand curve corresponds to a point at which both the goods market and the money market are in equilibrium. f.
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Chapter 13 - Chapter 13 I. Introduction a. Recall that...

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