# Slide Show #10 AGEC 430 Macroeconomics of Agriculture Spring 2010.

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Slide Show #10 AGEC 430 Macroeconomics of Agriculture Spring 2010

Handout #18

The Big 5 Macro Variables There are 5 key variables linking the food and fiber system with the general economy. They are: 1. Rate of inflation 2. Rate of interest 3. Rate of unemployment 4. Rate of growth in GDP 5. Rate of foreign exchange

The Big 5 Macro Variables 1.Rate of inflation – affects prices for farm inputs in the short run and interest rates in the longer run. 2.Rate of interest – affects farm interest expenses and farm land values. 3.Rate of unemployment – affects off-farm income of farm operator families, an important source of internal equity capital for many farmers and ranchers. 4.Rate of growth in GDP – affects domestic demand for agricultural products (remember the income elasticity of demand. 5.Rate of foreign exchange – reflects the value of the dollar relative to client nation currencies and hence the export demand for agricultural products.

Handout #19

ieie MDMS QM

Substituting equations 1 and 2 into equation 3 and solving for the interest rate “i” Substituting equations 1 and 2 into equation 3 and solving for the interest rate “i”

A partial equilibrium focusing on the money market. As “Y” changes, it affects the rate of interest or “i”. A partial equilibrium focusing on the money market. As “Y” changes, it affects the rate of interest or “i”.

Substituting equations 6, 7 and 8 into equa- tion 9 and solving for “Y”…

Savings, measured by S in this equation 13, is the “S” in the IS curve.

A partial equilibrium focusing on the product market. As the rate of interest “I” changes, aggregate demand “Y” changes.

A general equilibrium for both the money and product market. This captures the only interest rate and level of GDP that satisfies both markets.

Expansionary Monetary Policy Policy Given Y and i, you can solve for investment and consumption expenditures

Expansionary Fiscal Policy Policy

The intersection of the IS and LM curves not only gives us the general equilibrium in the money and aggregate product markets, but it also gives us the general price level in the economy (i.e., CPI).

Expansionary monetary policy Expansionary monetary policy, for example, would shift the LM curve to the right. Lower interest rates would stimulate investment and shift the aggregate demand curve to the right. We saw this presented earlier in Handout #16, but not in this general equilibrium context.

Macro-Market-Micro

LS wr LELE L MAX UR %∆P Y POT Macro-Market-Micro Overview Macro-Market-Micro Overview LD

Wheat Market Dw Sw Pw e Qw e Wheat Producer MC Pw e MR qw e AC Implications for a Commodity Market and Individual Producer Profit Analysis MC Pw e MR qw e AC Average profit = MR – AC at qw e (distance between red and blue dots) Total profit = average profit times qw e (shaded area) Average profit = MR – AC at qw e (distance between red and blue dots) Total profit = average profit times qw e (shaded area)

Expansionary Monetary Policy

LS wr LELE L MAX UR %∆P Y POT Macro-Market-Micro Overview Macro-Market-Micro Overview LD

LS wr LELE UR %∆P Step 1: Increase in the money supply shifts the LM curve to the right. Interest rates fall, suggesting an increase in invest- ment expenditures. LD 1

LS wr LELE UR %∆P Step 2: Aggregate demand increases, pulling up the general price level, and thus requires addition production. LD 2

LS wr LELE UR %∆P Step 3: The increased production requires additional labor, shifting the labor demand curve to the right and pushing up wages rates. LD 3

LS wr LELE UR %∆P Step 4: The decline in unemployment rate and presence of both demand pull and cost push inflation results in a movement down the Phillips curve. LD 4

Wheat Market Dw Sw PW e QW e 5 One of the factors that shifts the demand curve for a commodity is disposable income. This not only shifts the aggregate demand curve for all goods and services but intermediate goods like wheat (step 5). This increases the price of the commodity.

Wheat Market Dw Sw PW e QW e Wheat Producer MC PW e MR qw e AC 5 6 The increase in the price of the commodity means that the price that price takers like our wheat producer rises (step 6). Average profit rises (spread between green dots now instead of yellow dots). And more is supplied, increasing revenue and profit since qw e is greater.

Farm Balance Sheet: 1/ Current assetsUp Current liabilities Up (accrued taxes) Land values 2/Up Fixed liabilities No change Fixed assetsNo change Net worth or equity Up Total assetsUp Total debt and equity Up 1/ Assumes a current market value balance sheet. 2/ Capitalized land values rise due to higher farm income. 3/ Reflects assumption that taxes paid on last year’s income. Farm Income Statement: Farm revenueUp Farm expensesUp slightly Farm taxable incomeUp Income taxes 3/No change Net farm incomeUp Farm Income Statement: Farm revenueUp Farm expensesUp slightly Farm taxable incomeUp Income taxes 3/No change Net farm incomeUp Wheat Producer MC PW e MR qw e AC 6 The annual change in equity = retained earnings + net asset appreciation

Expansionary Fiscal Policy

LS wr LELE L MAX UR %∆P Y POT Macro-Market-Micro Overview Macro-Market-Micro Overview LD

LS wr LELE UR %∆P LD Step 1: A cut in the income tax rate shifts the IS curve to the right. Interest rates rise, but the tax cut suggests an increase in consumption expenditures. 1

LS wr LELE UR %∆P LD Step 2: Aggregate demand increases, pulling up the general price level, and thus requires addition production. 2

LS wr LELE UR %∆P LD Step 3: The increased production requires additional labor, shifting the labor demand curve to the right and pushing up wages rates. 3

LS wr LELE UR %∆P LD Step 4: The decline in unemployment rate and presence of both demand pull and cost push inflation results in a movement down the Phillips curve. 4

Wheat Market Dw Sw PW e QW e 5 One of the factors that shifts the demand curve for a commodity is disposable income. This not only shifts the aggregate demand curve for all goods and services but intermediate goods like wheat (step 5). This increases the price of the commodity.

Wheat Market Dw Sw PW e QW e Wheat Producer MC PW e MR qw e AC 5 6 The increase in the price of the commodity means that the price that price takers like our wheat producer rises (step 6). Average profit rises (spread between green dots now instead of yellow dots). And more is supplied, increasing revenue and profit since qw e is greater.

Farm Balance Sheet: 1/ Current assetsUp Current liabilities Up (accrued taxes) Land values 2/Up Fixed liabilities No change Fixed assetsNo change Net worth or equity Up Total assetsUp Total debt and equity Up 1/ Assumes a current market value balance sheet. 2/ Capitalized land values rise due to higher farm income. 3/ Reflects assumption that taxes paid on last year’s income. Farm Income Statement: Farm revenueUp Farm expensesUp slightly Farm taxable incomeUp Income taxes 3/No change Net farm incomeUp Farm Income Statement: Farm revenueUp Farm expensesUp slightly Farm taxable incomeUp Income taxes 3/No change Net farm incomeUp Wheat Producer MC PW e MR qw e AC 6 The annual change in equity = retained earnings + net asset appreciation

Summary Comments Contractionary policy actions will reverse the conclusions shown in this slide show. Know the four combinations of gaps and macro policy in Handouts #16 and #17 (also see Slide Show #9). One will be on exam #2, being worth 20 points. Be able to extend your analysis to the market and producer level illustrated in this slide show. This follow up may be on exam #2, and maybe worth another 5-10 points.

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