EC250 Chapter Notes - Chapter 14: Aggregate Demand, Best Response, Real Interest Rate
Document Summary
Reaction function formula that shows how boc responds to changing economic conditions: r = r1 + b( target) increase in real interest rate = decrease in quantity of rgdp demanded by households/firms. Two points on ad curve: a = at r1, rgdp equals pgdp so output gap (y) is 0 and = target, b = now let"s say inflation rate increases to 2 response is to raise r. Is and ad are different: they both show ae but with different variables, is = r and ae, ad = and ae. Change in inflation target: if boc increases inflation target, they will lower r, causes increase in ae ad will shift right. These shifts are not permanent ae, rgdp, and pgdp are all equal in the long run. As curve shows the total quantity of output, or rgdp, that firms are willing and able to supply at a given inflation rate: same as the phillip"s curve.
