Chapter9
• The circular flow of income and expenditures shows how
money flows through the four basic markets that make up
the macroeconomy. Those four markets are the
• goods and services market,
• resource market,
• loanable funds market, and
• foreign exchange market.
• The aggregate demand curve shows the various quantities of
domestically produced goods and services that purchasers
are willing to buy at different price levels. It slopes
downward to the right because the quantity purchased by
consumers, investors, governments, and foreigners (net
exports) will be larger at lower price levels.
• The aggregate supply (AS) curve shows the various quantities
of goods and services that domestic suppliers will produce
at different price levels. The short-run aggregate supply
(SRAS) curve will slope upward to the right because higher
product prices will improve profit margins when important
cost components like long-term leases and wages set by
collective bargaining agreements are temporarily fixed in
the short run.
• In the long run, output is constrained by the economy’s
resource base, current technology, and efficiency of its
existing institutions. A higher price level does not loosen
these constraints. Thus, the long-run aggregate supply
(LRAS) curve is vertical.
• Two conditions are necessary for long-run equilibrium in the
goods and services market: (a) the quantity demanded
must equal the quantity supplied, and (b) the actual price
level must equal the price level decision-
makers anticipated when they entered into their long-term
agreements. When long-run equilibrium is present, output
will be at its maximum sustainable level.
• The aggregate demand-aggregate supply model reveals the
determinants of the price level and real output. In the short
run, price and output will move toward the intersection of
the aggregate demand (AD) and short-run aggregate supply
(SRAS) curves. In the long run, price and output will
gravitate to the levels represented by the intersection of
the AD, SRAS, and LRAS curves.
• When the economy is in long-run equilibrium, potential
output will be achieved and full employment will be
present (the actual rate of unemployment will equal the
natural rate).
• It is important to distinguish between real interest rates and
money interest rates. The real interest rate reflects the real
burden to borrowers and the payoff to lenders after
inflation. It is equal to the money rate of interest minus the
inflationary premium. The inflationary premium depends
on the expected rate of inflation.
• When the exchange rate is determined by market forces,
trade deficits will be closely linked with an inflow of capital.
Conversely, trade surpluses will be closely linked with an
outflow of capital.
• Macroeconomic equilibrium requires that equilibrium be
