macsg12 - 12 [27] Aggregate Demand in the Goods and Money...

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293 12 [27] Aggregate Demand in the Goods and Money Markets C hapter objectives: 1. Identify the two links between the money market and the goods market. Outline the reasons for the inverse relationship between planned investment and the interest rate. 2. Distinguish between fiscal policy and monetary policy. Distinguish between a contractionary and an expansionary policy, specifying the tools used in each case. 3. Explain when and how the crowding-out effect occurs. Explain the impact of the interest sensitivity of investment demand on the effectiveness of monetary policy. 4. Outline the issues involved in determining the optimal policy mix. 5. Derive and explain the slope of the aggregate demand curve. Explain what the curve represents. 6. Identify how aggregate demand is affected by monetary and fiscal policy actions. 7. Explain what is depicted by the IS curve and the LM curve. Although there is some important new material in this chapter (aggregate demand), much is not new—it combines material that has been built up independently. The best study tip is to review your notes before beginning this material. If you lose track of the discussion, refer to the earlier chapters. The most common mistake is to not recognize how the goods and money markets influence each other. Think of it this way: If the demand for goods and services is to be met, then output in the goods market must match demand, and this affects the dollar volume of transactions in the economy. Money demand must adjust to this circumstance. The money market must respond by matching the demand and supply of money. Changes in the money market affect the interest rate, which impacts on investment decisions in the goods market. And so on. ±±± LEARNING TIP: The Practice Test Solutions section in this guide carefully traces through the detail of the relationships between the goods market and money market. Think of the “Answers” as additional practice— verify each step and verify why each incorrect option is incorrect. The text contains some “economic shorthand.” It’s useful for you in note taking, it shows the logical sequence of events, and it summarizes all the steps neatly. For some extra practice, work through each case in the textbook’s Table 12.1 (27.1).
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294 Study Guide to Principles of Macroeconomics Caution! It is easy to forget that an economic notation like “ ” represents underlying behavioral relationships that you must understand (rather than just memorize). Take the time to think about each step in these very condensed sequences. ± BRAIN TEASER: By July 2003 the Fed had cut interest rates to a 40-year low to help stimulate the economy. The federal funds rate was hovering around 1%. Can nominal (market) interest rates be less than zero? This would mean that you would be willing to deposit $100 today with a promise of receiving only $95 a year from now. The alternative is simply holding the $100 in cash. Why might you be willing to accept a negative interest rate?
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macsg12 - 12 [27] Aggregate Demand in the Goods and Money...

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