Macro Chapter 9 An Introduction to Basic Macroeconomic Markets

Macro Chapter 9

An Introduction to Basic Macroeconomic Markets

7 Learning Goals1) List the four key markets in the macroeconomy.2) Describe the relationship between the general price

level and the amount of goods and services demanded.

3) Describe the relationship between the general price level and the amount of goods and services supplied in the short-run and long-run.

4) Investigate how aggregate demand and supply determine the price level, output, and employment.

5) Recognize how the resource market is connected to the goods and services market.

6) Recognize how the loanable funds market is connected to the goods and services market.

7) Recognize how the foreign exchange market is connected to the goods and services market.

• Four key markets coordinate the circular flow of income. • The resource market coordinates the actions of businesses demanding resources and households supplying them in exchange for income.

• The loanable funds market brings net household saving and the net inflow of foreign capital into balance with the borrowing of businesses and governments.

• The foreign exchange market brings the purchases (imports) from foreigners into balance with the sales (exports plus net inflow of capital) to them.

• The goods & services market coordinates the demand for and supply of domestic production (GDP).

The Circular Flow Diagram

Aggregate Demand for Goods and Services

What is Aggregate Demand (AD)?

The summation of all goods and services desired

AD is the relationship between two variables: amount of goods desired and the price level

Graph of AD:

Transmitter Question Next

Q9.1 For an economy, aggregate demand equals

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1. consumption plus investment plus government purchases plus exports.

2. consumption plus investment plus government purchases plus (exports minus imports).

3. consumption plus investment plus (taxes minus transfers) plus (exports minus imports).

4. consumption plus investment plus government purchases plus (imports minus exports).

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Y = C + I + G + X

Aggregate Supply of Goods and Services

What is Aggregate Supply (AS)?

The summation of all goods and services offered for sale

AS is the relationship between two variables: amount of goods offered for sale and the price level

When thinking about AS, you MUST distinguish between the short run and the long run

Graph of SRAS:

Why is SRAS upward sloping?

In the short run, many resources prices are fixed

An increase in the price level increases profits so firms are willing to make more goods

Graph of LRAS:

Why is LRAS vertical?

In the long run, people fully adjust their behavior to account for price changes

Resource prices are flexible so an increase in the price level does not change profits

LRAS is determined by technology, resources, and efficiency; NOT by prices

Two Transmitter Questions Next

Q9.2 In the context of aggregate supply, the short run is defined as the period during which

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1. some prices are set by contracts and cannot be adjusted.

2. prices can change, but neither aggregate supply nor aggregate demand can shift.

3. individuals have sufficient time to modify their behavior in response to price changes.

4. quantity changes cannot occur in response to changes in relative prices.

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Q9.3 In the context of aggregate supply, the long run is defined as the period during which

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1. some prices are set by contracts and cannot be adjusted.

2. prices can change, but neither aggregate supply nor aggregate demand can shift.

3. individuals have sufficient time to modify their behavior in response to price changes.

4. quantity changes cannot occur in response to changes in relative prices.

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LRAS is the economy’s full employment rate of output!!

LRAS = potential GDP

The natural rate of unemployment occurs at LRAS

Equilibrium in the Goods and Services Market

Since we have SRAS and LRAS, we will have short run equilibrium and long run equilibrium which can be different equilibrium points

Class Activity: How many different equilibrium points can you draw with the AD/AS curves?

Graph of equilibrium points:

Compare Models:

AD-AS_bus-cycle.pdf

Key Points

When the economy is in long run equilibrium:– (1) actual GDP = potential GDP– (2) actual unemployment rate = natural rate of

unemployment– (3) SRAS, LRAS, and AD are all equal

Class Activity: Draw the following AD/AS graph. Use it to answer the next 2 clicker questions.P level

Y

LRASSRAS

AD

(1) (2) (3)

Q9.4 (MA) Which of the following statements are true?

1. At point (1) actual GDP is greater than potential GDP

2. At point (1) actual GDP is less than potential GDP

3. At point (1) actual unemployment is greater than the natural rate of unemployment

4. At point (1) actual unemployment is less than the natural rate of unemployment





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Discuss with a neighbor and we’ll redo the question

Q9.5 (MA) Which of the following statements are true?

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Key Points

When the economy is in an expansionary phase:– (1) actual GDP > potential GDP– (2) actual unemployment rate < natural rate of

unemployment– (3) short-run equilibrium is greater than

average; greater than long-run equilibrium

Key Points

When the economy is in a recessionary phase:– (1) actual GDP < potential GDP– (2) actual unemployment rate > natural rate of

unemployment– (3) short-run equilibrium is less than average;

less than long-run equilibrium

Resource Market

Think primarily of labor as a resource

When businesses want to produce more goods, they will need more labor (resource demand increases)


Q9.6 Other things constant, an increase in resource prices will

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1. increase the demand for goods and services.

2. increase the cost of producing goods and services, which will lead to a higher price level.

3. reduce costs and improve profit margins, which will lead to an increase in aggregate supply in the goods and services market.

4. cause the natural rate of unemployment to rise.

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Loanable Funds Market

The loanable funds market is the coordination between borrowers and lenders

Borrowers demand funds

Lenders supply funds

The interest rate is the price:– Borrowers pay a price to receive money now– Lenders receive a price to wait

Interest Rates:

money interest rate = nominal interest rate

real interest rate = money rate – inflation

The money, or nominal, interest rate is the only rate you can put in writing

The real rate will change, depending on inflation

Class Activity

If the real interest rate is 3% and the nominal interest rate is 5%, what is inflation?

If the nominal interest rate is 7% and inflation is 6%, what is the real interest rate?


Q9.7 Which of the following is the most accurate statement about real and nominal interest rates?

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1. Real interest rates can be either positive or negative, but nominal interest rates must be positive.

2. Real interest rates and nominal interest rates must be positive.

3. Real interest rates must be positive, but nominal interest rates can be either positive or negative.

4. Real interest rates and nominal interest rates can be either positive or negative.

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Foreign Exchange Market

Suggestion

Read the following sections in Chapter 19:

Foreign Exchange Market, p. 378-380

Balance of Payments, p. 387-391

Exchange Rates, Current Account Balance, and Capital Inflow, p. 391-394

Graph of Foreign Exchange:

See exhibit 9 on p. 191

Quantity offoreign currency

Dollar price(of foreign currency)

S (exports + capital inflow))

D (imports + capital outflow)

Q

P1

Depreciationof dollar

Appreciationof dollar


Video:



S (exports + capital inflow)


Q

P1




Dollar price (of foreign currency) = how many dollars you must give up to get foreign currency

Class Activity

Consider Mexico. Who demands pesos and why? Who supplies pesos and why?

Another way to think about foreign exchange

“Regular” price is an exchange rate: $ for goods– Example: exchange $3.00 for Chick-fil-A

sandwich– Graph: (next page)

Another way to think about foreign exchange

Dollar price = $$ / foreign currency

Example: $1 / £1 then $0.50 / £1

Equivalently, $1 / £1 then $1 / £2– $1 now buys twice as much in England



S (exports + capital inflow))


Q

P1




Dollar price (of foreign currency) = how many dollars you must give up to get foreign currency

Foreign exchange terms:The dollar appreciates when you need fewer dollars to receive the same amount of foreign currency (or, equivalently when you can buy more foreign goods with the same $1)– The dollar is referred to as strong or

strengthening– Americans import more, export less

Foreign exchange terms:The dollar depreciates when you need more dollars to receive the same amount of foreign currency (or, equivalently when you can buy less foreign goods with the same $1)– The dollar is referred to as weak or

weakening– Americans import less, export more

If the dollar appreciates against another currency, then that currency depreciates against the dollar

Some exchange rates:

US-Japan

US-Euro

US-weighted index

US-China

Key relationship:

A trade deficit (imports > exports) requires an inflow of capital (foreigners purchasing US financial and real assets > Americans purchasing foreign assets)

A trade surplus (exports > imports) allows for an outflow of capital (Americans purchasing foreign assets > foreigners purchasing US assets)

Trade Balance

Capital Outflow

Capital Inflow

Class Activity: Should the US have a strong or weak dollar? Why?

2 Transmitter Questions Next

Q9.8 (MA) If the dollar price of the English pound goes from $1.75 to $1.50, then

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1. the dollar has appreciated against the pound.

2. the dollar has depreciated against the pound.

3. the pound has appreciated against the dollar.

4. the pound has depreciated against the dollar.

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Q9.9 (MA) If the dollar price of the English pound goes from $1.75 to $2.00, then

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1. Americans will find English goods cheaper.

2. Americans will find English goods more expensive.

3. The English will find American goods cheaper.

4. The English will find American goods more expensive.

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Optional Credit

Read “NYT_Schwartz-Dollar_decline.pdf” on Blackboard. A 10-question “quiz” will be available until the start of class on (availability). You will have three attempts at the quiz and only your highest score will count.

Q9.10 Who is your idol?

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1. Donkey

2. Pinocchio

3. Doris

4. Prince Charming

5. Three Blind Mice

6. Gingi

7. Captain Hook

8. Puss N Boots

9. Shrek & Fiona

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7 Learning Goals1) List the four key markets in the macroeconomy.2) Describe the relationship between the general price

level and the amount of goods and services demanded.

3) Describe the relationship between the general price level and the amount of goods and services supplied in the short-run and long-run.

4) Investigate how aggregate demand and supply determine the price level, output, and employment.

5) Recognize how the resource market is connected to the goods and services market.

6) Recognize how the loanable funds market is connected to the goods and services market.

7) Recognize how the foreign exchange market is connected to the goods and services market.

Documents

Macro Chapter 9 An Introduction to Basic Macroeconomic Markets