MRS. NICHOLSON - AP Economics

April 25 - Money and Money Supply

Today's Plan

Use the below information to complete your 3 column paper with 5 Basic Principles of the theory and then the Government Roles in that theory.


Watch the flipped video on the characteristics of Money and complete Money Notes sheet for you notes for the future exam.


Watch the 2nd video for Measuring Money Supply


Complete the Handout #2 - Measuring Money


Read "Money and Inflation: A Functional Relationship" and complete the question guide.


If you finish everything and have time remaining you need to work on independent study. AP Exam students. Sign up for www.learnerator.com and begin quizzing yourself in each content area.

School of Economics - Big Sheet with 3 coulumns

Five Classical Economics Basics

(Neo-Classical, Supply Side, Trickle Down, Monetarism, Free Trade)

· In the long run, competition forces companies to be efficient and develop new technologies. If a company doesn’t, it will lose market shares to those that do.

· In the long run, competition encourages companies to reduce prices. If a company doesn’t, it will lose market shares to those that do.

· In the long run, competition encourages companies to create better wages and working conditions. If a company doesn’t, workers will move to companies that do.

· In the long run, competition will create self correcting stability and prosperity.

· If stability is lost, suppliers can correct the surpluses and shortages with new prices, production goals, and wage rates. For shortages: raise prices, produce more, pay more to extra workers. For surpluses: lower prices, produce less, pay less to fewer workers.

What is the Role of Government in Classical Economics?

· Protect private property rights that allow the incentive to profit.

· Protect economic law and order to allow competition without cheating.

· Defend the nation to allow open competitive markets.

· Promote free trade to allow competitive forces to benefit all nations.

· Lower taxes to restrict governmental interference and encourage industrial development.

How will Classical Economics show up on the AP?

· Flexible currency exchange rates

· Long Run Aggregate Supply lines on the Aggregate Model

· Straight Short Run Aggregate Supply lines on the Aggregate Model

· Flexible price adjustments between the SRAS and the LRAS that return the shifts back to equilibrium (example: 2012 Q.3 parts C and D)

· Comparative Advantage problems

· The use of the Phillips Curve and logic behind a country’s Natural Rate of Unemployment

· MV = PQ (The amount of money available times the velocity of money will be equal to the level of prices times the quantity of goods and services.

2nd Column

Keynesian Economics Basics

(Protective Tariffs, Neo-Keynesian)

In the long run, competition can create better standards of living for market economies.

· However, societies don’t live in the long run. The immediate, short run is critical for making a living, taking care of families, putting food on the table. In the short run, all competitive markets have flaws that create one crisis after another.

· Businesses often are not efficient and many fail, therefore they always under-employ the workforce.

· Say’s Law of suppliers balancing the economy is mythical. Businesses can’t always jettison workers, cut salaries, reduce prices because resources didn’t get more plentiful and society will reject these “solutions”. Wages are usually “sticky” when forced downward. This all is known as the “Ratchet Effect”.

· Consumers will fear both inflation and unemployment. When they fear inflation, they will panic buy to beat the price increases, thus causing worse inflation. When they fear unemployment, they quit buying and cause surpluses, thus creating more unemployment.

What is the Role of Government in Keynesian Economics?

· Focus on the short run. In the short run there will be flaws. “In the long run, we are all dead.”

· Forget the Supply solutions to problems, create the correct amount of demand.

· During the inevitable recessions, lower taxes to boost consumption spending and raise government spending to create jobs. Run deficits as needed (and assumed).

· During the occasional inflation spirals, raise taxes to dampen consumption spending and decrease government spending to slow job growth. Run surpluses to pay off older debts and then get ready for the next recession.

· Create stabilizers to dampen the effects of the next crisis. Protect the elderly with social security programs and slow the panic of the unemployed with compensation. Give subsidies to key industries to keep technology developing and keep jobs plentiful.

How will Keynesian Economics show up on the AP?

· Any use of the phrase Fiscal Policies will connect to Congressional/Keynesian decisions.

· A segmented Short Run Aggregate Supply line (as found in older editions of texts still used in many states: horizontal range = Keynesian range)

· The assumption that fiscal policies used to fight recessions will always create deficits

· The concept of “crowding out” as a consequence of expansionary fiscal policies

· Changes in the Money Demand line on the Money Market Graph

3rd Column

Monetary Policy Basics

(Central Bank Policies, Federal Reserve Policies, Fine Tuning)

· Competitive markets can flourish but need goals of stable growth and low inflation rates.

· Keynesians policies fail to work quickly enough to help with tax cuts and job programs. By the time the “stimulus” plan is debated and passed by any legislative body, the recession that caused the policy debate has probably ended on its own.

· Keynesian policies really collapse during times of inflation because legislative bodies won’t raise taxes and cut government job programs. The tax increases get leaders removed from office and the job programs are usually entrenched in fiercely protective bureaucracies and lobby groups.

· Stagflation creates a crisis that no elected government can easily solve. Fight the excessive unemployment and increase the inflation even more. Fight the inflation and increase the excessive unemployment even more.

· Inflation is always more damaging to any economy than unemployment. Unemployment hurts the jobless; inflation hurts everyone in the society.

What is the Role of Government in Monetary Policies?

· A non-political agency can regulate banks, the money supply, and interest rates. It will be especially effective when painful and unpopular decisions need to be made and will make them in a timely manner. This can be the central banking system.

· During recessions, impact the overall investment demand through tools that increase the incentive to borrow. This will be lower interest rates.

· During inflation, impact the overall investment demand through tools that decrease the incentive to borrow. This will be higher interest rates.

· During stagflation, when public officials don’t know what to do or are unwilling to do much, curtail the inflation first. Get the economy back to normal investment levels and then unemployment problems will be lessened.

· Build central bank rules and tools that keep the overall growth rate steady and manageable. Keep banks from taking on too much risk and pushing the “correct” amounts of loanable funds into the economy.

How will Monetary Policies show up on the AP?

· Any mention of central bank policies

· Any mention of “open market operations” which will always connect to bond markets

· The changes in the Supply of Money line on the Money Market graph

· The general use of the Investment Demand graph and the Loanable Fund Market Graph

  • · The use of domestic interest rates as the key to “borrowing money” for private gross investment (Ig). The use of international interest rates as an incentive for investment in a country’s markets.

Watch the below video on Money and complete the Money Sheet

(Macro) Episode 29: What is Money?

Money Supply - M1, M2, and M3

    There are several definitions of the supply of money. M1 is narrowest and most commonly used. It includes all currency (notes and coins) in circulation, all checkable deposits held at banks (bank money), and all traveler's checks. A somewhat broader measure of the supply of money is M2, which includes all of M1 plus savings and time deposits held at banks. An even broader measure of the money supply is M3, which includes all of M2 plus large denomination, long‐term time deposits—for example, certificates of deposit (CDs) in amounts over $100,000. Most discussions of the money supply, however, are in terms of the M1 definition of the money supply.

Complete Handout #2

Read Handout #3 Article - turn back in once you have completed the assignment

Answer the questions that go along with the article