Essential Graphs in Macroeconomics

Here is a short list of required graphs for macro that can assist students in understanding theoretical
material. Students must be able to analyze these graphs as well as construct them.
I. The Production Possibility Curve (PPC) or the Production Possibility Frontier (PPF)

(a) INVESTMENT
GOODS
A C

PPC
B
Possibilities
Curve
CONSUMPTION
GOODS
Point A. Efficiency = full employment of existing economic resources
Point B. Inefficiency = underemployment of existing economic resources
Point C. Unattainable with the existing quantity and quality of economic resources and the level of
technology
(b) Movement from the Recession to the Full-employment = movement from the point inside the PPC
to the point on the PPC
INVESTMENT
GOODS
A

PPC
Possibil
B
ities
Curve
CONSUMPTION
GOODS
(c) The long-run Economic Growth = increase in the Production Possibilities due to the increase in the
Quantity and/or Quality of Economic Resources and/or in the Level of Technology = rightward shift of
the PPC = movement from point A to point C
INVESTMENT INVESTMENT INVESTMENT
GOODS GOODS GOODS

C
PPC2
A Possibilities
PPC1 Curve
Possibilities
CONSUMPTION CONSUMPTION
Curve CONSUMPTION GOODS GOODS
GOODS (C)
 II. The Circular Flow Model
(a) The Simple (two-sector) Model: household and business, resource and product markets
(Circular Flows in a Simple Private Closed Economy)
Spending on goods & services Revenues

Goods & Services Goods Market Goods & Services

Households Firms

Economic Resources Economic Resources

Incomes Resource Market Factor Payments

(b) The Simple (two-sector) Model with the Financial Market

(Circular Flows in a Simple Private Closed Economy with Financial Market)

Consumption Spending (C) Revenues

Goods & Services Goods Market Goods & Services

Investment Spending (I)

Saving (S) Loanable Funds (F)

Households Financial Market Firms

Economic Resources Economic Resources

Resource Market
Incomes Factor Payments
 (c) The Model with the Government Sector (three-sector model or closed-economy macro model)
(Circular Flows in a Mixed Closed Economy)

Revenues
Goods Market
Consumption Investment
Spending (C) Spending (I)
Government
Purchases (G)
Taxes (Tx)
расходы (С) Taxes (Tx)
Government
Sector
Transfer Subsidies (Sb)
Payments (Tr)
Households Firms
Government Sector Loan to the
Saving (SG) Government
Private Sector
Saving (S) Loanable Funds (F)
Financial Market

Incomes Factor Payments

Resource Market

(d) The Open-Economy (four-sector) Macro Model

(Circular Flows in an Open Economy)

Exports (Ex)

Foreign Sector Imports (Im) Revenues

Goods Market
Consumption Investment
Spending (C) Government Spending (I)
Taxes (С)
(Tx) Purchases (G)
расходы Taxes (Tx)
(= Part of National Saving, SNAT)

Government
Sector
Transfer Subsodies (Sb)
Net Capital Outflow

Payments (Tr)
Households Firms
Government Sector Loan to the
Saving (SG) Government
Private Sector
Saving (S) Loanable Funds (F)
Financial Market

Net Capital Inflow

(= Foreign Sector Saving, SF)

Resource Market
Incomes Factor Payments
 III. The Business Cycle
(a) Extremal points: A and C – peak, point B – trough.
Phases of business cycle: time period from A to B – recession or contraction,
time period from B to C – recovery or expansion.

REAL
GDP

C TREND (Y*)

A
BUSINESS CYCLE (Y)

TIME (years)

(б) Real output gaps

REAL GDP

C TREND (Y*)
Yn
Inflationary Gap
Y*n BUSINESS CYCLE (Y)
Y*m
Recessionary Gap
Ym
B

Year m Year n TIME (years)

IV. The Keynesian Cross Model

(a) The Consumption Line, where С – autonomous consumption spending and mpc – marginal
propensity to consume.
CONSUMPTION
SPENDING (C)
C С mpcYD

mpc
С

DISPOSABLE
INCOME (YD)
 (b) The Shifts and the Slope of the Consumption Line

CONSUMPTION
Increase in autonomous Increase in marginal
CONSUMPTION
SPENDING (C) consumption spending SPENDING (C) propensity to consume
С2 mpcYD С mpc 2 YD

С mpc1YD
С1 mpcYD

С2 mpc2
mpc mpc1
С1 С

DISPOSABLE DISPOSABLE
INCOME (YD) INCOME (YD)

(c) The Saving Line, where С is autonomous saving, and mps – marginal propensity to save.
SAVING (S)

S С mpsYD

DISPOSABLE
mps INCOME (YD)
С

(d) The Shifts and the Slope of the Saving Line

SAVING (S) SAVING (S) Increase in marginal
Increase in autonomous
saving propensity to save
S2 С mps2YD
S2 С2 mpsYD
S1 С1 mpsYD S1 С mps1YD

С2 DISPOSABLE mps2 DISPOSABLE

INCOME (YD) mps1 INCOME (YD)
mps С
С1

(e) The Investment Line

INVESTMENT In the (I – Y) space REAL In the (r – I) space

SPENDING (I) INTEREST
RATE (r)

I(Y)
I(r)
1
/b
REAL OUTPUT (Y) INVESTMENT SPENDING (I)
 (f) The Equilibrium in the Two-sector Model, where YE – equilibrium level of income/output,
AEP – planned aggregate expenditures, and IP – planned investment spending
AGGREGATE AE = Y
EXPENDITURES (AE)
AEP = C + IP
E

mpс

450
YE REAL OUTPUT (Y)

INVESTMENT (I),
SAVING (S)

S С mpsYD
E
IP
mps YE REAL OUTPUT (Y)
С

(g) The Multiplier Effect of the increase in autonomous planned investment spending, where A is
autonomous spending.
AGGREGATE AE = Y
EXPENDITURES (AE) AEP(I2)
B
AEP(I1)

A2 С I2
A
A1 С I1
450
Y1 Y2 REAL OUTPUT (Y)

(h) The “Paradox of Thrift”

INVESTMENT (I), INVESTMENT (I),
SAVING (S) SAVING (S)
Increase in autonomous saving Increase in the marginal propensity to save
S2 S2
S1 B S1
B A A
IP IP

С2 Y2 Y1 REAL OUTPUT (Y) mps2 Y2 Y1 REAL OUTPUT (Y)

mps1
С1 С
 (i) The Equilibrium in the Three-sector Model (closed economy) and in the Four-sector Model (open
economy)
AGGREGATE AGGREGATE
EXPENDITURES (AE) EXPENDITURES (AE)
Closed Economy Open Economy
AE = Y AE = Y
AEP = C+ IP+G
AEP = C+ IP+G+NX
E E

mpc-mpm
mpc

450 450
YE REAL OUTPUT (Y) YE REAL OUTPUT (Y)

(g) Output gaps and expenditure gaps, where YE – equilibrium (short-run) output, and Y* – full-
employment (long-run) or potential output.

AGGREGATE AGGREGATE
EXPENDITURES (AE) EXPENDITURES (AE)
Recessionary Gap Inflationary Gap
AE = Y AE = Y
AEP AEP
E E

450 450
YE < Y* REAL OUTPUT (Y) Y* < YE REAL OUTPUT (Y)

V. The Fiscal Policy

(a) Changes in Government Purchases: increase in G = expansionary fiscal policy,
decrease in G = contractionary fiscal policy

AGGREGATE AGGREGATE
EXPENDITURES (AE) EXPENDITURES (AE)
Increase in G Decrease in G
AE = Y AE = Y
AEP( G2 ) AEP( G1 )
B AEP( G1 ) A AEP( G2 )

A B
G G
450 450
Y1 Y2 REAL OUTPUT (Y) Y2 Y1 REAL OUTPUT (Y)
 (b) Changes in Lump-sum Taxes: decrease in T x = expansionary fiscal policy,
increase in T x = contractionary fiscal policy

AGGREGATE AGGREGATE
EXPENDITURES (AE) EXPENDITURES (AE)
Decrease in T x Increase in T x
AE = Y AE = Y
AEP( T x2 ) AEP( T x1 )
B AEP( T x1 ) A AEP( T x2 )

A B
ΔC = -mpc×Δ T x ΔC = -mpc×Δ T x
450 450
Y1 Y2 REAL OUTPUT (Y) Y2 Y1 REAL OUTPUT (Y)

(c) The Balanced Budget Policy: G Tx

AGGREGATE
EXPENDITURES (AE) AE = Y
AEP( G2 , T x 1 )
B AEP ( G2 , T x2 )
AEP( G1 , T x1 )
С
A
ΔC = -mpc×Δ T x
G
450
Y1 Y2 Y1' REAL OUTPUT (Y)

ΔY = G Tx

(d) Changes in the Proportional Tax Rate: decrease in t = expansionary fiscal policy,
increase in t = contractionary fiscal policy.

AGGREGATE AGGREGATE
EXPENDITURES (AE) Decrease in t EXPENDITURES (AE)
Increase in t
AE = Y AE = Y
AEP(t2) AEP(t1)
AEP(t1) A AEP(t2)
B

B
A

450 450
Y1 Y2 REAL OUTPUT (Y) Y2 Y1 REAL OUTPUT (Y)
(e) Changes in Transfer Payments: increase in T r = expansionary fiscal policy,
decrease in T r = contractionary fiscal policy
AGGREGATE AGGREGATE
EXPENDITURES (AE) EXPENDITURES (AE)
Increase in T r Decrease in T r
AE = Y AEP( T r2 ) AE = Y
AEP( T r1 )
B AEP( T r1 ) A AEP( T r2 )

A
ΔC = mpc×Δ T r ΔC = mpc×Δ T r B

450 450
Y1 Y2 REAL OUTPUT (Y) Y2 Y1 REAL OUTPUT (Y)

(f) The Impact of Automatic Stabilizers on the Business Cycle

REAL
GDP
BUSINESS CYCLE
(with the presence of built-in stabilizers)

TREND

BUSINESS CYCLE
(with the absence of built-in stabilizers)

TIME (years)

(g) The Laffer Curve

TAX REVENUES (Tx)

B
Txmax
A
Tx

topt t TAX RATE (t)

 VI. The Loanable Funds Market
(a) Equilibrium in the loanable funds market (where rE - real rate of interest, FE – equilibrium quantity
of loanable funds, FD – demand for loanable funds, and FS – supply of loanable funds)
REAL INTEREST
RATE (r)
FS

E
rE

FD

FE QUANTITY OF
LOANABLE FUNDS (F)
(b) Shifts in the demand for loanable funds

Increase in G, Tr or in I Decrease in G, Tr or in I
REAL REAL
INTEREST FS INTEREST S
RATE (r) RATE (r) F S2
F

r2 B
r1 A
r1
A r2
FD2 B
FD1 FD1
FD2
QUANTITY OF QUANTITY OF
LOANABLE FUNDS (F) LOANABLE FUNDS (F)

(c) Shifts in the supply of loanable funds in the closed economy

Increase in Tx or in SPRIVATE Decrease in Tx or in SPRIVATE
REAL S
REAL FS2
INTEREST F 1 INTEREST FS
FS21
RATE (r) S RATE (r)
F 2

r2 B
A
r1 r1
A
r2 B

FD FD

QUANTITY OF QUANTITY OF
LOANABLE FUNDS (F) LOANABLE FUNDS (F)
 (g) Crowding-out effect of the expansionary fiscal policy (the case of an increase in government
purchases)

AGGREGATE REAL INTEREST

REAL INTEREST
EXPENDITURES (AE) RATE (r) RATE (r)
AE = Y
AEP( G2 , I1 ) FS

A' AEP ( G2 , I 2 )
AEP( G1 , I1 ) B
r2 r2 B
B
r1 r1 A
A
I A I(r)
FD2
G FD1
Y1 Y2 Y1' REAL
OUTPUT (Y)
QUANTITY OF I2 I1 INVESTMENT
LOANABLE FUNDS (F) SPENDING (I)

VII. The Money Market

a) Equilibrium in the money market (where iE – equilibrium nominal rate of interest,
(M/P)E – equilibrium quantity of real money balances, (M/P)D – demand for real money balances
(= real demand for money), MS/P – real supply of money)

MS
NOMINAL
INTEREST P
RATE (i)

iE E
M D
( )
P

M QUANTITY OF REAL
( )E
P MONEY BALANCES (M/P)

(b) Shifts of the demand for money

Increase in real demand for money Decrease in real demand for money
S
M MS
NOMINAL NOMINAL
INTEREST P INTEREST P
RATE (i) RATE (i)
i2 B

i1 A i1 A
M M D
( )D2 ( ) 1
P i2 B P
M M
( ) D1 ( )D2
P P
M QUANTITY OF REAL M QUANTITY OF REAL
( )E ( )E
P MONEY BALANCES (M/P) P MONEY BALANCES (M/P)
 (c) Crowding-out effect of the expansionary fiscal policy (the case of an increase in government
purchases): alternative explanation
NOMINAL
AGGREGATE REAL
INTEREST MS INTEREST
EXPENDITURES (AE)
RATE (i) P RATE (r)
AE = Y
AEP(G2,I1)
A' AEP (G2,I2)
AEP(G1,I1) r2 B
i2 B
B
r1 A
i1 M D
I A ( ) 2 I(r)
A P
G M
( ) D1
P
Y1 Y2 Y1' REAL
OUTPUT (Y) QUANTITY OF REAL I2 I1 INVESTMENT
MONEY BALANCES (M/P) SPENDING (I)
(d) Shifts of the supply of money
Increase in the real supply of money Decrease in the real supply of money
S
NOMINAL M S1 M S 2 NOMINAL M S2 M 1
INTEREST INTEREST P P
P P
RATE (i) RATE (i)

B
i2
i1 A i1 A
i2 B
M D M D
( ) ( )
P P
M M QUANTITY OF M M QUANTITY OF
( )1 ( ) 2 ( ) 2 ( )1 REAL MONEY
REAL MONEY P P
P P BALANCES (M/P)
BALANCES (M/P)

VIII. The Bonds Market

(a) Equilibrium in the bonds market (where PBE – equilibrium bonds price, BE – equilibrium quantity
of bonds, BD – demand for bonds, and BS – supply of bonds)
BONDS
PRICE (PB) BS

E
PBE

BD
QUANTITY OF
BE BONDS (B)
 (b) Changes in the bonds market: an increase in the demand for bonds BD in the case of the excess
MS M
supply of money in the money market ( > ( ) D ); an increase in the supply of bonds BS in the
P P
M MS
case of the excess demand for money in the money market ( ( ) D > )
P P
Increase in BD Increase in BS
BONDS BONDS
PRICE (PB) BS PRICE (PB) BS1
BS 2
B
PB2
A A
PB1 PB1
B
PB2
BD2
BD1 BD

QUANTITY OF QUANTITY OF
BONDS (B) BONDS (B)

IX. Monetary Policy

(a) Money transmission mechanism under monetary expansion

NOMINAL M S1 M S 2 LRAS
REAL PRICE
INTEREST P P INTEREST LEVEL (P) SRAS
RATE (i) RATE (r)
i1 r1 A
A
i2 B r2 B P2 B
P1 A
M AD1
( )D I
P AD2
M M QUANTITY OF I1 I2 INVESTMENT Y1 Y* REAL
( )1 ( ) 2 REAL MONEY OUTPUT (Y)
P P SPENDING (I)
BALANCES (M/P)

(b) Money transmission mechanism under monetary contraction

S
NOMINAL
M S2 M 1 REAL PRICE LRAS
INTEREST P P INTEREST LEVEL (P) SRAS
RATE (i) RATE (r)
i2 B B
r2
i1 A r1 A P1 A
P2 B
M D AD1
( ) I
P AD2
QUANTITY OF I2 I1 INVESTMENT Y2 Y* REAL
REAL MONEY SPENDING (I) OUTPUT (Y)
BALANCES (M/P)
(c) The Shape of the Real Money Demand Curve

In the Keynesian Model In the Monetarist Model

NOMINAL NOMINAL
INTEREST INTEREST
RATE (i) RATE (i)

M D
( )
P
M D
( )
P
1 1
/h /h’
QUANTITY OF REAL QUANTITY OF REAL
MONEY BALANCES (M/P) MONEY BALANCES (M/P)

(d) The Shape of the Investment Demand Curve

In the Keynesian Model In the Monetarist Model

REAL REAL
INTEREST INTEREST
RATE (r) RATE (r)

I(r)
I(r)
1 1
/b /b’
INVESTMENT INVESTMENT
SPENDING (I) SPENDING (I)

X. The Labour Market

W
(a) Equilibrium in the labour market (where ( ) E equilibrium real wage, LE – equilibrium quantity
P
of labour, LD – demand for labour, and LS – supply of labour)
REAL WAGE
W LS
( )
P

W E
( )E
P

LD

LE QUANTITY
OF LABOUR (L)
 (b) Changes in the demand for labour (the main cause are the changes in the labour productivity MPL)
REAL WAGE Increase in LD REAL WAGE Decrease in LD
S
W L W S
(
P
) (
P
) LF S2
W B
( )2
P W
( )1 A
W P
( )1
P A W
D ( )2
L (MPL2) P B LD(MPL ) 1
D D
L (MPL1) L (MPL2)
QUANTITY L2 L1 QUANTITY
L1 L2
OF LABOUR (L) OF LABOUR (L)
(c) Changes in the supply of labour
REAL WAGE Increase in LS REAL WAGE Decrease in LS LS
2
W LS1 W LFSS21
( ) ( )
P LS2 P
W B
( )2
W A P
( )1
P W A
( )1
W P
( )2 B
P
LD LD

QUANTITY OF L2 L1 QUANTITY OF
L1 L2 LABOUR (L) LABOUR (L)

XI. Aggregate Demand and Aggregate Supply Model

(a) Aggregate Demand Curve
PRICE
LEVEL (P)

B
P2
A
P1
AD
REAL
Y2 Y1 OUTPUT (Y)

(b) Shifting Aggregate Demand

PRICE Increase in AD PRICE Decrease in AD
LEVEL (P) LEVEL (P)
Aggregate Demand Aggregate Demand

AD2 AD1
AD1 AD2
REAL REAL
OUTPUT (Y) OUTPUT (Y)
 (c) Shifting Aggregate Supply

PRICE Increase in AS PRICE Decrease in AS

LEVEL (P) LEVEL (P)
AS1
Aggregate Demand AS2
Aggregate Demand
AS2 AS 1

REAL REAL
OUTPUT (Y) OUTPUT (Y)
(d) Equilibrium in the AD-AS Model
Point E: Long-run Equilibrium (where Y* – an equilibrium full-employment level of real output and
PE – an equilibrium price level, AD – aggregate demand curve, SRAS – short-run aggregate supply
curve, and LRAS – long-run aggregate supply curve)
PRICE
LEVEL (P) LRAS
SRAS

PE E

AD
REAL
Y* OUTPUT (Y)
(e) Output gaps in the AD-AS model

PRICE Recessionary Gap PRICE Inflationary Gap

LEVEL (P) LEVEL
LRAS (P) LRAS
SRAS SRAS

A
A P
P
AD
AD REAL REAL
Y < Y* OUTPUT (Y) Y* < Y OUTPUT (Y)

(f) Shocks of Aggregate Demand

Positive (= increase in AD) Negative (= decrease in AD)
PRICE PRICE
LEVEL LRAS LEVEL LRAS
(P) (P)
SRAS SRAS
P2 B
P1 A P1 A
P2 B
AD2
AD1
AD1 AD2
REAL REAL
Y* Y2 OUTPUT (Y) Y2 Y* OUTPUT (Y)
E
 (g) Shocks of Aggregate Supply
Favorable (= increase in SRAS) Adverse (= decrease in SRAS)
PRICE PRICE
LEVEL LRAS
LEVEL LRAS SRAS2
(P) SRAS1 (P)
SRAS1
SRAS2 B
A P2
P1 P1 A
P2 B

AD AD
REAL REAL
Y* Y2 OUTPUT (Y) Y2 Y* OUTPUT
(Y)
(h) Shifts of LRAS curve
Increase in Production Decrease in Production
PRICE Possibilities PRICE Possibilities
LEVEL LEVEL
LRAS1 LRAS2 (P) LRAS2 LRAS1 SRAS2
(P)
SRAS1
SRAS1
SRAS2 B
A P2
P1 P1 A
P2 B

AD AD
REAL REAL
Y*1 Y*2 OUTPUT (Y) Y*2 Y*1 OUTPUT (Y)

(i) Self-correction of the economy after a negative aggregate demand shock (classical view)
PRICE
LEVEL LRAS
(P) SRAS1
SRAS2
A
P1
P2 B C
AD1
AD2
REAL
Y2 Y* OUTPUT (Y)
(f) Effects of fiscal and monetary policy actions
Expansionary Policy Contractionary Policy
(= increase in AD) (= decrease in AD)
PRICE PRICE
LEVEL LRAS LEVEL (P) LRAS
(P) SRAS
SRAS
A
P2 B P1 B
P1 A P2
AD2 AD2
AD1 AD1
REAL REAL
Y1 Y* OUTPUT (Y) Y* Y1 OUTPUT (Y)
 (g) Fiscal policy – the ‘supply-siders’ approach
PRICE
LEVEL (P) LRAS
SRAS1
SRAS2

A
P1
P2 B
AD REAL
Y1 Y* OUTPUT (Y)

XII. The Phillips Curve

(a) Short-run Phillips curve, where u* is the natural rate of unemployment
INFLATION Original Phillips Curve INFLATION Short-run Phillips Curve
RATE (π) RATE (π)
SRPC
SRPC

UNEMPLOYMENT UNEMPLOYMENT
RATE (u) RATE (u)
u*
N
(b) Long-run Phillips curve and its shifts (Warning: the long-run Phillips curve cannot shift without the
shift of the SRPC).
INFLATION INFLATION
RATE (π) LRPC RATE (π) LRPC1 LRPC2

UNEMPLOYMENT UNEMPLOYMENT
u* RATE (u) RATE (u)
u*1 u*2
(c) Effects of Aggregate Demand shocks:
Positive AD shock (= increase in aggregate demand)
PRICE INFLATION
LEVEL (P) RATE (π)
SRAS
SRPC

P2 B
π2 B
P1 A
π1 A
AD2
AD1 REAL UNEMPLOYMENT
Y1 Y2 OUTPUT (Y) RATE (u)
u2 u1
 Negative AD shock (= decrease in aggregate demand)
PRICE INFLATION
LEVEL (P) RATE (π)
SRAS
SRPC

P1 A
π1 A
P2 B
π2 B
AD1
AD2 REAL UNEMPLOYMENT
Y2 Y 1 OUTPUT (Y) RATE (u)
u1 u2
(d) Effects of the increase in inflationary expectations
PRICE INFLATION
LEVEL (P) SRAS1 RATE (π)
SRAS2
C
P3
B π2 C
P2 B
P1 A π1
AD2 A SRPC(πe2)
AD1 SRPC(πe1)
Y1 Y2 REAL u2 u1=u* UNEMPLOYMENT
OUTPUT (Y) RATE (u)
(e) Effects of AS shifts: adverse supply shock
PRICE INFLATION
LEVEL (P) SRAS2 RATE (π)
SRAS1
B
P2
P1 A π2 B
π1
A SRPC2
AD
SRPC1
REAL u1 u2 UNEMPLOYMENT
Y 2 Y1
OUTPUT (Y) RATE (u)

(g) Disinflation policy under adaptive expectations

PRICE INFLATION
LEVEL (P) LRAS SRAS1 RATE (π) LRPC
SRAS2
A
P1
π1 A
P2 B
P3 π2 C B
C
AD1
SRPC(πe1)
AD2 SRPC(πe2)
Y2 Y*=Y1 REAL u*=u1 u2 UNEMPLOYMENT
OUTPUT (Y) RATE (u)
(h) Disinflation policy under rational expectations
PRICE INFLATION
LRAS SRAS1 LRPC
LEVEL RATE (π)
(P) SRAS2
A
P1
π1 A

P2 C π2 C
AD1
SRPC(πe1)
AD2 SRPC(πe2)
Y* REAL u* UNEMPLOYMENT
OUTPUT (Y) RATE (u)

XIII. Economic Growth

(a) The change in real GDP over time
REAL GDP
TREND

Y*5
Y*4
Y*3
Y*2
Y*1

1920 1950 1980 2010 2040 TIME (years)

(c) The increase in production possibilities of the economy

INVESTMENT
GOODS
B

A PPC2
PPC1
Possibilities
CONSUMPTION
Possibilities Curve GOODS
(c) The increase in the long-run aggregate supply and in the potential level of output
Curve

PRICE
LEVEL (P) LRAS1 LRAS
SRAS1
2
SRAS2
A
P1
P2 B

AD
REAL
Y*1 Y*2 OUTPUT (Y)
 XIV. The Foreign Exchange Market
(a) Equilibrium in the foreign exchange market (where eE – equilibrium exchange rate, i.e. the price of
national currency = number of units of foreign currency for 1 unit of national currency = international
value of national currency, QE – equilibrium quantity of national currency, D – demand for national
currency, and S – supply of national currency)
EXCHANGE
RATE (e) S

E
eE

D
QUANTITY OF
NATIONAL CURRENCY (Q)
(b) Shifts of the demand for national currency
Increase in the demand Decrease in the demand
EXCHANGE for national currency EXCHANGE
for national currency
RATE (e) RATE (e)
S
S

B
e2
e1 A
e1 A
e2 B
D2
D1 D1
D2
QUANTITY OF QUANTITY OF
NATIONAL CURRENCY (Q) NATIONAL CURRENCY (Q)

(c) Shifts of the supply of national currency

Increase in the supply of Decrease in the demand

EXCHANGE national currency EXCHANGE for national currency
RATE (e) RATE (e) S2
S1 S1
S2
e2 B
A
e1 e1 A
e2 B

D D

QUANTITY OF NATIONAL QUANTITY OF NATIONAL

CURRENCY (Q) CURRENCY (Q)
 (d) The Central Bank’s interventions under the fixes exchange rate system

The case of the increase in the The case of the decrease in the
demand for national currency EXCHANGE demand for national currency
EXCHANGE for currency
for currency RATE (e)
RATE (e) S1 SCB
SCB S1

B A
ē ē
A B
D2
D1 D1
D2
QUANTITY OF NATIONAL QUANTITY OF NATIONAL
CURRENCY (Q) CURRENCY (Q)

The case of the increase in the The case of the decrease in the
supply of national currency supply of national currency
EXCHANGE EXCHANGE
RATE (e) for currency
S2
RATE (e)
S1=SCB
S1=SCB
S2 A’
A=C
ē ē
A=C
A’

D D

QUANTITY OF NATIONAL QUANTITY OF NATIONAL

CURRENCY (Q) CURRENCY (Q)

XV. The Loanable Funds Market in the Open Economy

An influence only on the supply of loanable funds:
(i) capital inflow = inflow of foreign saving SF to the national economy
= an increase in aggregate saving = increase in the supply of loanable funds
(ii) capital outflow = outflow of part of national saving SNAT to the foreign sector
= a decrease in aggregate saving = decrease in the supply of loanable funds
Capital Inflow Capital Outflow
REAL INTEREST FS1 REAL INTEREST
RATE (r) RATE (r) FS2
FS2 FS1
A B
r1
r2
r2 B r1 A

FD FD
QUANTITY OF QUANTITY OF
LOANABLE FUNDS (F) LOANABLE FUNDS (F)