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Money and Banking
Chapter 11
When it comes to production in a firm, producers appear in three categories
namely A, B, and C, where A represents the producers whose supplies are adequate for
the demands they receive. B represents producers who have insufficient supplies to
meet their demands whereas C denotes those who have insufficient demands to enable
them dispose supplies. All these categories coexist within the nation’s economy. As
such, they are affected by varying supply and demand curves differently. However, they
are not usually individually aware of the net excesses of deficiencies in demand.
Therefore, they act individually to salvage their situation whose actions culminate in the
leveling of the economic field back to normalcy. When inequalities arise between GDP,
APE, and ASF, firms innocently make changes that are referred to as macroeconomic
coordination processes (MCP), which straighten the imbalances and inequalities
automatically, thus resulting in a state of equilibrium. Considering that the ASF is
constant, such imbalances could occur in two ways. First, the APE (gross demand)
could be greater than the GDP (gross supply) illustrated by GDP < APE = ASF. The
linear inequality depicts a net excess demand although individual B and C producers
are not aware of the net situation. Producers under category B react by increasing
prices and output, thus leading to positive economic profits, which foster entry into the
industry, whereas producers in group C reduce their prices and output, thus leading to
negative economic profits. The net excess demand faced by B is higher relative to the
net excess shortage faced by C by exactly the same capacity that is reflected in the
difference between GDP and APE. Consequently, there are greater economic profits by

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B-producers’ price and output increment in relation to C-producers’ price and output
reductions. This culminates in increased market entry into Group B industries and the
reflected exit from Group C industries. The aggregate outcome is an increase in entry
and output, which pushes the net outcome upwards until the prices fall back to normal.
The second inequality is caused by the GDP being less than the APE as illustrated by
APE< GDP =ASF. The shortage of demand faced by producers in Group C is greater
than the excessive demand that accosts B-producers by the same value as the
difference between GDP and APE. C-producers react by reducing prices and output
while B-producers increase prices and output. However, this time, the level of reduction
by C exceeds the level of increases by B, thus culminating in net negative economic
profits, which mean that, overall, prices (p) and GDP shall fall. This in turn causes the
shifting from C through the industry exit as people move into B via the market entry. The
net exit and output decrements cause the net output to reduce and prices to shoot up to
recuperate the overall negative net profits until the industry exits come to an end when
the profits get back to zero. What has happened at this point is that, eventually, the GDP
shall have reduced by a greater degree than the original difference between GDP and
APE. Inflation occurs when there are barriers to the entry and/or exit, and when there
are impediments to the market forces.
Chapter 12
There are six possible causes of upsets to the macroeconomic coordination
processes. This chapter deals with only three of them, namely increased APE,
increased ASF, and decreased GDP. The commonality among these three is the
temporary nature of the consequences of shocks where provisional adjustments could

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span, particularly with regard to supply inflation. The assumptions held in this analysis
include that the economy at the onset is at macroeconomic equilibrium where
GDP=APE=ASF and that, during a particular shock’s lifespan, no other shock hits such
an economy. The constants include employment, output, interest rates, and price levels.
The first shock, which is the demand-caused expansion, features an increase in APE
that is triggered either by domestic or foreign factors. How much the prices and outputs
shall change shall be determined by the nature of the firms in question. Therefore,
farmers would react to demand expansion by increasing their prices and rationing
available supplies since they have to wait until the next season for further production.
On the other hand, manufacturers would react by employing more staff and/or
increasing their output to satisfy the new demand. The immediate result is reflected in
the growth and prosperity of the economy. Soon afterwards, interest rates increase. The
situation is now GDP<APE = ASF. This trend of more employment, interest rates,
outputs, and profits continues until the illustration is GDP=APE=ASF, but at a higher
threshold of GDP in terms of more profits. This attracts new entrants into the market
who in turn increase employment and outputs. Soon, interest rates, prices, and profits
shall reduce to their normal levels, albeit being at a higher GDP than it was initially.
Since equilibrium has now been achieved, the macroeconomic coordination processes
come to a halt. Now, the cumulative effect on the economy is positive as employment
shall have increased and living standards shall be higher. This domino-like effect is
replicated in the next two shocks, which are money and credit-caused expansion. They
occur when moneylenders have the need to dispose excessive funds to unwilling
borrowers as opposed to when borrowers want money, with banks and shylocks being

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unwilling or unable to lend out. Lenders thus lower interest rates to make credit
attractive. The reduced interests are in the market for a short while after which both
interest and prices shall pick up sharply with similar effects on the economy, namely
growth and prosperity. The other shock, which is the cost-induced expansion or inflation,
is a result of a reduction in the operation cost in businesses, which is reflected in the
reduction of prices and increase in sales, employment, outputs, and profits until
producers realize their profits, which occur at a higher GDP. Finally, supply-caused
inflation is a result of disaster, natural, or otherwise including earthquakes, political
uprisings, and other civil actions such as boycotts that compromise the efficiency of the
industry, thus leading producers to dispose their products. Such producers hesitate at
further production. In fact, they would rather increase their prices and hoard their
products than to produce afresh in the light of the recent disasters.
Chapter 13
This section presents the other three shocks, which are related to inflation,
depression, and recession. Demand-caused recession occurs after a fall in the net
demand by households, businesses, and foreign markets for various reasons.
Consequently, funding and supply are at par resulting in the relationship
APE<GDP=ASF. The reason for this parity is that the funding that would have been
used for demands is now taken up by producers to support their accumulated
inventories of supplies that have not been dispatched. The characteristic trend for these
shocks (decreased APE, decreased ASF, and increased GDP) includes an increase in
unemployment, outputs, and prices resulting in negative net profits that in turn increase
the exit from the industry to lower the GDP. The unemployment keeps up, with the

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interest rates increasing until the negative profits have been reduced to zero, where
these factors now stabilize. The prices and economic profits shall not change. However,
for the temporary drop to facilitate the elimination of the net negative profits, the overall
effect of these changes will be a smaller economy, either a recession (unemployment
and reduction of output) or a depression depending on how extreme it is. However, the
actual occurrence of other variables in this trend is constantly shifting so that, in money
and credit-caused recession, the variable is a decline in the supply of funding, meaning
that there is a demand by borrowers but not enough money or speed of transfer that is
facilitated by acquisition from non-bank lenders. The cause of this deficiency is a desire
by moneylenders to reduce the volume of outstanding loans. The economy reacts by an
increase in ASF, which happens concurrently with a reduction in some demand, as the
new interest rate is higher where crowding out indicates a lower demand. Eventually,
the ASF becomes equal to the GDP, but at a lower APE, thus culminating in the events
mentioned above (small economy and low living standards as well as a recession or
depression), with interest rates remaining high. In cost-push inflation, businessoperating costs increase. Producers transfer the burden to consumers via price
increase and output reduction. Unemployment and interest rate levels also escalate.
The result is an inflationary recession considering that jobs and outputs are reduced
(also known as stagflation). The growth problem involves the investment component of
business, which features producers investing in capacity building only to have lesser
returns than they anticipated, thus getting de-motivated and halting capacity building.
Therefore, the key components are insufficient demand and funding. The downward
motion of the economy follows to conclude in the loss of any increase in GDP that is

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acquired due to capacity building and eventually a reduction of GDP to levels lower than
what they were initially. In conclusion, these shocks indicate that high output levels or
low unemployment can be directly proportional to positive high inflation thus
disapproving (to some extent) the absolute position adopted by the Phillips Curve
theory, which posits that unemployment automatically results in increased inflation.
Chapter 14
Classical macroeconomic structures in the 1900s before the great depression
were based on finances that depended on the gold held by the treasury. Banks were the
primary lenders. Other money lending financial institutions such as Ford Financial were
still budding. Consequently, the financial analyses indicated that money and velocity
were constant because gold did not accumulate interest. Hence, a vertical line reflected
the ASF. This kind of financial analysis lacked the interest component. Therefore, it
would not be prudent to apply it in the present financial situation. If demand increased,
moneylenders would hike interest rates. However, such an analysis would not reflect the
effect of such an increase on quotients such as employment and output. Interest rates
would continue increasing until the market evens out when crowding out brings
equilibrium between ASF and APE. When demand is low, economists’ ADF would equal
APE because the idea that producers would need to borrow to manage to accumulate
inventories is not feasible to economists. Therefore, the interest rates would dive
perpetually because moneylenders are better off lending out even at lower interests
than keeping money that is not appreciating.
Concerning ASF, the assumption was that, so long as businesses were making
the most out of their sales (maximum profits), an influx or shortage of funding was

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improbable. In case there was excess funding, interest rates would drop and demand
funds would increase until such a time when ASF would equal APE, with a higher GDP.
Similarly, if the funding became inadequate, interest rates would hike, with crowding out
culminating in ASF = APE, with a lower GDP. Employment and output are not an issue.
The relationship with GDP is so that, if GDP decreases, prices would be hiked.
Consequently, ASF would decrease, thus causing APE to decline to the level of GDP. An
increase in GDP leads to a decrease in price and an increase in ASF. This further leads
to the dropping of the level of interest rates and increasing APE to the level of GDP. This
happy-go-lucky attitude held by classical economists of the independent capacity of
macroeconomics to even its own excesses and restore equilibrium lasted until the great
depression. The great depression was contrary to the traditional expectations. It lasted
too long and did not seem to have the capacity to straighten itself. This bred a sense of
curiosity with regard to the question of absolutely free market forces. The proposed
solution was on price cuts when demand went too low. However, this mentality was
flawed because the only sector affected by the reduced interest rates is that of plant and
equipment, which counts for only 11% of the business world. Therefore, the major
differences between the classical and the modern view of macroeconomics include time
and perception. Based on time, classical economists believed that employment and
output discrepancies would be settled after a temporary lapse in price and interest rate
levels. In terms of perception in modern macroeconomics, employment, price, output
and interest rates remain at the new levels. In fact, they do not revert automatically
unless upon creation of new policies.
Chapter 15

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The status of the macroeconomic coordination processes is somewhat
unregulated. The system works without any specific objective except for the
equalization of GDP, ASF, and APE. At times, this can be detrimental to some sectors
such as employment. Therefore, some proposed controls have been established to
direct the MCP. Monetary policy works by the federal government’s interference. The
federal government has at its disposal tools that can affect the money quotient (M),
which in turn increases or decreases the ASF that in turn affects employment, output,
price, and interest rates. The Federal Reserve System’s goals in this regard include
promoting maximum employment and moderating interest rates. However, this objective
is unsustainable because some of the quotients in the end are indirectly proportional
such as maximum employment and stable prices. By pursuing moderate long-term
interest and maximum employment, the federal government is at a better position for
combating business cycles that are characteristic of long-term macroeconomic
coordination processes. On the other hand, if for instance the federal government
chooses to counter inflation by shooting down prices, the effect shall be felt as money
and credit shock to the economy, which shall in turn lead to further unemployment,
lower outputs, and higher interest rates. These conditions shall take the economy back
to its initial or even worse position, which indicates that the government should lay off
stable prices as a goal of the monetary policy. With the natural lapse of the MCP, the
prices shall go back down in due time. Inherent inconsistencies in terms of policies
could at times clog the MCP processes to inhibit any further government controls. This
would be the case if for instance a depression or recession goes on for extensive
periods during which suppliers hoard products and/or lenders’ funds are maintained idly

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without interest accumulation in the form of liquidity traps. The cause for this situation is
usually a misuse of tight monetary policies whose original purpose is usually to prevent
abuse of the monetary authority in the instigation and maintenance of inflation.
Monetary and fiscal policies currently manipulate inflation for solutions to the
destabilization of equilibrium. Nonetheless, in effect, the related MCP reacts to changes
in demand by transferring the effects to both employment and prices simultaneously.
Consequently, the solution thereby lies in alternative policies for maintaining
unemployment at minimum levels and for the regulation of prices. A possible suggestion
for a price regulation policy is the tax-based income policy. Such a policy would require
employers and employees that issue and receive wages that are higher than the
stipulated threshold to pay higher tax, with the ones with lower wages receiving tax
credits. This strategy would be an incentive especially concerning businesses that
increase their prices beyond a certain threshold to keep them stable. As a result, they
would suffer higher tax cuts than their rivals or counterparts who keep their prices below
the established threshold to receive tax credits.
Chapter 16
It is now easier to establish and implement market policies because the United
States’ dollar and other currencies have the mandate to fluctuate pursuant to changes in
demand and supply of foreign markets. There are two accounts, namely the current
accounts, which reflect the imports and exports among other related expenses, and the
financial accounts that reflect the status of foreign exchange in terms of securities,
bonds, and related trade products. The graph depicted is an indication of the state of
affairs between the United States and other European Union countries in the recent

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years. It reflects that the status of the euro-dollar rations indicates a preference by the
EU traders of the US as an investment destination than for the EU as an investment
destination by the US. This position is potentially hazardous because, in the absence of
external or internationally agreed upon rules, some countries could easily take
advantage and profit unjustly. To conquer it, the notion of a pegged exchange rate in
system offers a viable solution. It works so that the international rules have established
a certain threshold known as a BP line, which domestic governments are expected to
pass legislation to ensure compliance as opposed to exceeding this standard.
Concerning flexible rates and domestic policies, if the interest rates in the United States
suddenly dropped, the European Union would suddenly look appealing to the US
investors who would then cause an increase in exports to the EU. On the other hand,
the US would no longer appeal to the EU investors who would then prefer to trade
elsewhere. The result is that the US’ exports would exceed imports. This case would
cause the value of the dollar to depreciate. The major dysfunction in the current system
is that it takes congress ages to promulgate legislation about the fiscal policies.
However, since the monetary policies are under the ambit of professionals, a divide is
evident in the levels of development that negates the possibility of a productive
coordination of these two policies.
Since monetary policy is different from fiscal policy pursuant to the management
of either (monetary – federal reserve officials; fiscal – congress), coordination of these
segments is difficult to conceive. It would be preferable if the congress relinquished
some control such as the authority over taxes to professional handling for optimum
coordination results. This would work best if for instance the congress delegated the

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responsibility for taxes or other such funds to a federal reserve that is established
strictly for these purposes. It would then hand over such a body to professionals who it
should allow a level of flexibility to allow them to formulate policies that would become
effective and measurable fiscal policies. Consequently, such a mandated body would
have jurisdiction over both monetary and fiscal policies as a way of allowing them to
develop in tandem.