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Equilibrium Income

Equilibrium Income. Keynesian Approach: AE d determines Y (income/output) produced Can there be limitations to this link? YES because interest rates and/or prices might change that will reduce the effect on Y. . Interest Rates.

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Equilibrium Income

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  1. Equilibrium Income • Keynesian Approach: AEd determines Y (income/output) produced • Can there be limitations to this link? YES because interest rates and/or prices might change that will reduce the effect on Y.

  2. Interest Rates • Interest rates are determined by the supply and demand of loanable funds. • Let’s take a closer look at this market. Money Market Financial Market Bond Market Equities Market

  3. Money Market • What is money?

  4. Historical Development of Money • No Money: Barter Economy (goods for goods) • Money as a medium of Exchange: Goods Money Goods • How did all start? • Precious metals, • Paper money backed by gold, • Paper money fractionally backed by gold, • Fiat money,

  5. Properties of a Good Medium of Exchange • Acceptable • Standardized quality • Durable • Valuable relative to its weight • Divisible

  6. The Functions of Money 1) Medium of Exchange 2) Unit of account 3) Store of Value 4) Standard of deferred payments

  7. Money Supply Today • Money supply (M1) Currency (in circulation) + demand deposits (TL and Foreign Currency) • Money supply (M2) M1 + Time deposits (TL and Foreign Currency)

  8. M1 and M2 in Turkey

  9. US Money Supply

  10. Can the Central Bank change MS? • YES!!! • HOW? • With some tools known as monetary policy tools. (Tools are instruments that a policy maker can change in order to influence the workings of an economy)

  11. Monetary Policy Tools • Discount Rate, • Reserve Requirement ratio, • Open Market Operations. How do they work? Need to look at how banking system work and money changes hands…

  12. Commercial Banks • Banks are profit seeking institutions. • They accept deposits, • They give loans • Public Banks (Ziraat, Halk …) and Private banks (IsBank, Akbank, Garanti …)

  13. Commercial Banks Balance Sheets

  14. Rules that commercial banks follow: • Hold the required reserve ratio determined by Central Bank. If required reserve ratio (rr) is 15%, then in equilibrium (Reserves/ Deposits)*100 ratio=15 %. e.g. If Total Deposits are 2000 billion TL, then reserves need to be 300 billion TL. (Reserves/ Deposits)*100 ratio=(300/2000)*100=15 %

  15. A new deposit comes into Bank One

  16. Bank One uses this new deposits in giving out new loans (Reserves/deposits)*100= 15 %. Result: Creates a new loan equal to 850.

  17. The new loan comes back to Bank Two New loans of 722.5 TL are created by Bank Two

  18. This will repeat ∞ times • Total change in the deposits: 1000+ (0.85*1000)+(0.85*1000)2+(0.85*1000)3+… (0.85*1000)∞= • Total change = • Change in total deposits=

  19. Money supply • Money market • Tools to increase the MS • Discount rate increase, • Reserve requirement ratio decrease, • Open Market Operations (Buy bonds) I Q of money

  20. Money demand • Money market • Types of Money demand • Transaction demand, • Speculative demand, • Precautionary demand, • MD= L(Y, i) or • MD= 5*Y – 3*i I Q of money

  21. Money demand • Money market • If Y increases, then MD curve shifts to the right • MD= L(Y, i) or • MD= 5*Y – 3*i I Q of money

  22. Money market equilibrium • Money market MS=MD • Money supply MS= 1000 • Money demand MD= L(Y, i) or MD= 5*Y – 3*I (For a given Y level you will be able to determine equilibrium interest rate) I Q of money

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