Macroeconomics

Summary

1.

The dynamic model of aggregate demand and aggregate supply combines

five economic relationships: an equation for the goods market, which relates

quantity demanded to the real interest rate; the Fisher equation, which

relates real and nominal interest rates; the Phillips curve equation, which

determines inflation; an equation for expected inflation; and a rule for

monetary policy, according to which the central bank sets the nominal

interest rate as a function of inflation and output.

2.

The long-run equilibrium of the model is classical. Output and the real

interest rate are at their natural levels, independent of monetary policy. The

central bank’s inflation target determines inflation, expected inflation, and

the nominal interest rate.

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P A R T   I V

Business Cycle Theory: The Economy in the Short Run

P R O B L E M S   A N D   A P P L I C A T I O N S

the five equations to derive the value of each

variable in the model. Be sure to show each

step you follow.