An Introduction to Basic Macroeconomic Markets Macro Chapter 9 An Introduction to Basic Macroeconomic Markets

7 Learning Goals List the four key markets in the macroeconomy. Describe the relationship between the general price level and the amount of goods and services demanded. Describe the relationship between the general price level and the amount of goods and services supplied in the short-run and long-run. Investigate how aggregate demand and supply determine the price level, output, and employment. Recognize how the resource market is connected to the goods and services market. Recognize how the loanable funds market is connected to the goods and services market. Recognize how the foreign exchange market is connected to the goods and services market.

The Circular Flow Diagram 4/16/2017 The Circular Flow Diagram 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 goods & services market coordinates the demand for and supply of domestic production (GDP). The foreign exchange market brings the purchases (imports) from foreigners into balance with the sales (exports plus net inflow of capital) to them. The loanable funds market brings net household saving and the net inflow of foreign capital into balance with the borrowing of businesses and governments.

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:

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Q9.1 For an economy, aggregate demand equals consumption plus investment plus government purchases plus exports. consumption plus investment plus government purchases plus (exports minus imports). consumption plus investment plus (taxes minus transfers) plus (exports minus imports). consumption plus investment plus government purchases plus (imports minus exports). 60

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 some prices are set by contracts and cannot be adjusted. prices can change, but neither aggregate supply nor aggregate demand can shift. individuals have sufficient time to modify their behavior in response to price changes. quantity changes cannot occur in response to changes in relative prices. 60

Q9.3 In the context of aggregate supply, the long run is defined as the period during which some prices are set by contracts and cannot be adjusted. prices can change, but neither aggregate supply nor aggregate demand can shift. individuals have sufficient time to modify their behavior in response to price changes. quantity changes cannot occur in response to changes in relative prices. 60

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 Class Activity: Draw the following AD/AS graph. Use it to answer the next 2 clicker questions. LRAS P level SRAS AD Y (1) (2) (3)

Q9.4 (MA) Which of the following statements are true? At point (1) actual GDP is greater than potential GDP At point (1) actual GDP is less than potential GDP At point (1) actual unemployment is greater than the natural rate of unemployment At point (1) actual unemployment is less than the natural rate of unemployment At point (3) actual GDP is greater than potential GDP At point (3) actual GDP is less than potential GDP At point (3) actual unemployment is greater than the natural rate of unemployment At point (3) actual unemployment is less than the natural rate of unemployment 60

Discuss with a neighbor and we’ll redo the question

Q9.5 (MA) Which of the following statements are true? At point (1) actual GDP is greater than potential GDP At point (1) actual GDP is less than potential GDP At point (1) actual unemployment is greater than the natural rate of unemployment At point (1) actual unemployment is less than the natural rate of unemployment At point (3) actual GDP is greater than potential GDP At point (3) actual GDP is less than potential GDP At point (3) actual unemployment is greater than the natural rate of unemployment At point (3) actual unemployment is less than the natural rate of unemployment 60

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)

Transmitter Question Next

Q9.6 Other things constant, an increase in resource prices will increase the demand for goods and services. increase the cost of producing goods and services, which will lead to a higher price level. reduce costs and improve profit margins, which will lead to an increase in aggregate supply in the goods and services market. cause the natural rate of unemployment to rise. 60

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?

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Q9.7 Which of the following is the most accurate statement about real and nominal interest rates? Real interest rates can be either positive or negative, but nominal interest rates must be positive. Real interest rates and nominal interest rates must be positive. Real interest rates must be positive, but nominal interest rates can be either positive or negative. Real interest rates and nominal interest rates can be either positive or negative. 60

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

Foreign Exchange Market Dollar price (of foreign currency) S (exports + capital inflow)) D (imports + capital outflow) Depreciation of dollar Appreciation of dollar P1 Quantity of foreign currency Q

Video:

Foreign Exchange Market Dollar price (of foreign currency) S (exports + capital inflow) D (imports + capital outflow) Depreciation of dollar Appreciation of dollar P1 Quantity of foreign currency Q 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

Foreign Exchange Market Dollar price (of foreign currency) S (exports + capital inflow)) D (imports + capital outflow) Depreciation of dollar Appreciation of dollar P1 Quantity of foreign currency Q 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 Inflow Capital Outflow

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

2 Transmitter Questions Next

the dollar has appreciated against the pound. Q9.8 (MA) If the dollar price of the English pound goes from $1.75 to $1.50, then the dollar has appreciated against the pound. the dollar has depreciated against the pound. the pound has appreciated against the dollar. the pound has depreciated against the dollar. 60

Americans will find English goods cheaper. Q9.9 (MA) If the dollar price of the English pound goes from $1.75 to $2.00, then Americans will find English goods cheaper. Americans will find English goods more expensive. The English will find American goods cheaper. The English will find American goods more expensive. 60

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? Donkey Pinocchio Doris Prince Charming Three Blind Mice Gingi Captain Hook Puss N Boots Shrek & Fiona 60

7 Learning Goals List the four key markets in the macroeconomy. Describe the relationship between the general price level and the amount of goods and services demanded. Describe the relationship between the general price level and the amount of goods and services supplied in the short-run and long-run. Investigate how aggregate demand and supply determine the price level, output, and employment. Recognize how the resource market is connected to the goods and services market. Recognize how the loanable funds market is connected to the goods and services market. Recognize how the foreign exchange market is connected to the goods and services market.