Macro Unit 4:

Unit 4 Organizing Principles

In this unit you learn about money, banking, and how the central bank adjusts the money supply to influence the economy. You will start with the definition of money and why the money system is superior to the barter system. Keep in mind that there are two types of money: commodity money and fiat money.

Next you will learn about financial institutions and their role in the economy. Make sure that you can read a bank's balance sheet and that you know the difference between assets and liabilities. Make sure you understand how banks create money and the idea of fractional reserve banking. Be able to define demand deposits, required reserves, and excess reserves.

The most important graph in this unit is the money market: the supply and demand for money. Keep in mind that money includes cash and bank deposits. Feel comfortable drawing this graph and explaining how the central bank adjusts the money supply to change the nominal interest rate and influence the economy. This is called monetary policy.

The Federal Reserve uses three tools to shift the money supply: the reserve requirement, the discount rate, and open market operations. Make sure that you know how the FED uses these tools for expansionary and contractionary monetary policy. You will need to calculate the money multiplier and the total change in the money supply from an initial change in deposits. Also feel comfortable explaining the federal funds rate and how the FED uses open market operations to hit this target rate. The second key graph in this unit is the loanable funds market. This is supply and demand for loans. Make sure that you can draw and shift this curve and show how the real interest rate will be affected. Remember that the real interest rate is the nominal interest rate adjusted for inflation. Lastly, make sure that you can use the loanable funds market to show the result of deficit spending and the crowding out effect.