Federal reserve tools
open market operations, discount rate, reserve requirement
open market operations
Buying & selling government securities to
... [Show More] change the supply of money
Fed buys bonds
-decrease in the federal funds rate
-increase in money supply
Fed sells bonds
-increase in the federal funds rate
-decrease in money supply
discount rate
rate the Federal Reserve charges for loans to commercial banks
FED reduces discount rate
The Fed can alter the money supply by changing the discount rate. Conversely, a lower discount rate encourages banks to borrow from the Fed, increasing the quantity of reserves and the money supply.
Fed increases discount rate
The Fed can alter the money supply by changing the discount rate. A higher discount rate discourages banks from borrowing reserves from the Fed. Thus, an increase in the discount rate reduces the quantity of reserves in the banking system, which in turn reduces the money supply
reserve ratio
the fraction of deposits that banks hold as reserves
What would the Fed need to do with the reserve ratio in order to increase the money supply and aggregate demand in the economy?
Buys bonds from the public. Each new dollar deposited in a bank increases the money supply by more than a dollar because it increases reserves and, thereby, the amount of money that the banking system can create.
What would the Fed need to do with the reserve ratio in order to decrease the money supply and aggregate demand in the economy?
It sells government bonds to the public in the nation's bond markets. The public pays for these bonds with its holdings of currency and bank deposits, directly reducing the amount of money in circulation.
If the Fed uses monetary policy in a way that increases money supply, what effect will this have on interest rates and aggregate demand (consider them separately)?
When the Fed increases the money supply, it lowers the interest rate and increases the quantity of goods and services demanded for any given price level, shifting the aggregate-demand curve to the right. Conversely, when the Fed contracts the money supply, it raises the interest rate and reduces the quantity of goods and services demanded for any given price level, shifting the aggregate-demand curve to the left.
monetary policy
Government policy that attempts to manage the economy by controlling the money supply and thus interest rates.
fiscal policy
Government policy that attempts to manage the economy by controlling taxing and spending.
If the government uses fiscal policy to increase government spending what impact will this have on interest rates and aggregate demand?
The aggregate-demand curve shifts to the right.
If the government uses fiscal policy and cuts taxes, what effect will this have on interest rates and aggregate demand?
The tax cut shifts the aggregate-demand curve to the right. A tax increase depresses consumer spending and shifts the aggregate-demand curve to the left.
Effect of Income change on demand curve
shifts the demand curve
Normal goods vs inferior goods
If the demand for a good falls when income falls, the good is called a normal good.
If the demand for a good rises when income falls, the good is called an inferior good.
Explain how the price of related goods is related to changes in the demand curve?
Shifts the demand curve
Law of Demand
consumers buy more of a good when its price decreases and less when its price increases
demand curve
a graph of the relationship between the price of a good and the quantity demanded
Demand Curve Shifters
number of buyers, income, prices of related goods, tastes, expectations
Law of Supply
producers offer more of a good as its price increases and less as its price falls
supply and demand curve
Graph that includes both a supply curve and a demand curve. It shows the relationship between prices and the quantities of a product or service that is supplied and demanded.
Elastic vs. Inelastic
Elastic: describes demand that is very sensitive to a change in price
Inelastic: Describes demand that is not very sensitive to a change in price
price elasticity of supply
a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price
price elasticity of demand
a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price
Income Elasticity
A measure of how sensitive consumption of good X is to a change in a consumer's income
cross price elasticity
the percentage change in demand for product A that occurs in response to a percentage change in price of product B
In the net, how are price (P) and quantity (Q) changed by a simultaneous increase in demand and decrease in supply?
Increase in demand leads to an increase price and quantity
Decrease in supply leads to increase in prices and decrease of quantity
increase in demand and decrease in supply
increase in P and increase or decrease, or constant Q
In the net, how are price (P) and quantity (Q) changed by a simultaneous decrease in demand and supply?
Decrease in demand leads to lower prices and lower quantity.
Decrease in supply leads to higher prices and lower quantity
Decrease in demand and supply
increase or decrease, or constant P and decreases Q.
In the net, how are price (P) and quantity (Q) changed by a simultaneous decrease in demand and increase in supply?
Decrease in demand leads to lower prices and increased quantity
Increase in supply leads to lower prices and an increase in quantity.
Decrease in demand and increase in supply
Decrease in P and increase, decrease, or constant Q.
In the net, how are price (P) and quantity (Q) changed by a simultaneous increase in demand and supply?
Increase in demand leads to an increase price and quantity
Increase in supply leads to a decrease in price and increase in quantity
increase in both demand and supply
increase or decrease, or constant P and increases Q. [Show Less]