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Unformatted text preview: Chapter 12 outline I. Introduction a. Goods Market- the market in which goods and services are exchanged and in which the equilibrium level of aggregate output is determined. b. Money Market- the market in which financial instruments are exchanged and in which the equilibrium level of interest rate is determined. c. Events in the money market affect what goes on in the goods market, and events in the goods market affect what goes on in the money market. d. Only by analyzing the two markets together we can determine the values of aggregate output and the interest rate that are consistent with the existence in both markets. i. This also reveals how fiscal policy affects the money market and how monetary policy affects the goods market. II. The Links Between the Goods Market and the Money Market a. There are two key links between the goods market and the money market: i. Link 1: Income and the Demand for Money 1. The first link exists because the demand for money depends on income. 2. As aggregate output increases, the number of transactions requiring the use of money increases. 3. An increase in output, with the interest rate held constant, leads to an increase in money demand. 4. *Income, which is determined in the goods market, has considerable influence on the demand for money in the money market. ii. Link 2: Planned Investment Spending and the Interest Rate 1. The second link exists because planned investment spending depends on the interest rate. 2. Investment is not fixed instead; it depends on a number of key economic variables. (one is the interest rate) 3. The higher the interest rate is, the lower the level of planned investment spending 4. *The interest rate, which is determined in the money market, has significant effects on planned investment in the goods market. b. Investment, the Interest Rate, and the Goods Market i. There is an inverse relationship between the level of planned investment and the interest rate. ii. *When the interest rate falls, planned investment rises. When the interest rate rises, planned investment falls. iii. Investment refers to a firms purchase of new capital. iv. Whether a firm decides to invest in a project depends on whether the expected profits from the project justify its costs. Usually, a big cost of an investment project is the interest cost. v. The real cost of an investment project depends in part on the interest rate. vi. When the interest rate rises, it becomes more expensive to borrow, and fewer projects are likely to be undertaken 1. Increasing the interest rate, ceteris paribus, is likely to reduce the level of planned investment spending. 2. When the interest rate falls, it becomes less costly to borrow vii. Reducing the interest rate, ceteris paribus, is likely to increase the level of planned investment spending....
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This note was uploaded on 04/26/2009 for the course ECO 304K taught by Professor Hickenbottom during the Spring '10 term at University of Texas at Austin.
- Spring '10