Download An Introduction to Basic Macroeconomic Markets

Ch 9



Describe the four key macroeconomic
markets
Examine the relationship between the general
price level and the amount of goods and
services demanded.
Examine the relationship between the general
price level and the amount of goods and
services supplied in the short-run and longrun.





Read before class
Bring PowerPoints to class
Take notes
Find a study buddy
Visit office hours


Circular flow diagram
Four key markets
◦
◦
◦
◦

Goods and services
Resources
Loanable funds
Foreign exchange
Four new supply and demand markets
◦ what’s measured on each axis
◦ why curves have their slope

(Not yet thinking about shifts this chapter)

Fiscal Policy
◦ Changing taxes or government spending with the
purpose of achieving macroeconomic goals
◦ Conducted by Congress and the President

Monetary Policy
◦ Changing the money supply with the purpose of
achieving macroeconomic goals
◦ Conducted by the Federal Reserve System (The Fed)
Market
Demand
Supply
Price
(Final) Goods and
Services
Households
Businesses
Price Level
Resources
Businesses
Households
Wage
Loanable Funds
Borrowers
Savers
Interest Rate
Foreign Exchange
Americans
Foreigners
Exchange Rate
Flow of all domestically produced final-user
goods and services


Market encompassing the flow of
all final-user goods and services produced
within a country during a specific time period,
usually a year
Hey,
that’s the
definition
of GDP!
Demand (expenditures) Supply
•Households
•Businesses
•Governments
•Foreigners (net exports)
Price
Quantity
Businesses Price Level Real GDP

Aggregate Demand Curve – shows the
relationship between the price level and the
quantity of domestically produced goods and
services that all households, businesses,
governments, and foreigners are willing to
purchase
Increase in price level will
decrease the quantity of goods
and services demanded.
Price Level
P2
P1
AD
Output (real GDP)
Y2
Y1


1. A higher price level will decrease the
purchasing power of money
Example: Imagine you have $500 for the
month’s expenses and prices suddenly are 2X
as high 


2. A higher price level will increase the
demand for money and raise the real interest
rate, which will reduce additional purchases
People take money out of their interestbearing assets to pay for everyday spending;
Borrowing becomes more expensive

3. A higher price level will make domestically
produced goods more expensive, ceteris
paribus

Imports will increase (foreign goods cheaper);
Exports will fall; overall decrease in NX



Aggregate Supply Curve – shows the
relationship between the price level and the
quantity of domestically produced goods and
services that businesses are willing to sell
Short-run: upward sloping
Long-run: vertical
Increase in price level will
increase quantity supplied in
the short run
Price Level
SRAS
P2
P1
Output
Y1
Y2


SRAS – in the short run, an unanticipated
increase in the price level will increase the
profitability of businesses
***This is because resource prices are fixed in
the short run!!

The SRAS curve assumes that resource (input)
prices are “sticky” and slow to adjust.
But final goods
sell for more
No change in
input prices
Increase in price level will have
no impact on quantity supplied
in the long run
Price Level
LRAS
P2
P1
Output (real GDP)
YF

The LRAS curve is vertical because once
people have enough time to adjust contracts,
the price level will not impact output.
The price of coffee doesn’t actually
impact our ability to produce more
or less of it in the long run
Price Level
Buyers are willing to purchase
all the units that sellers are
willing to supply at the current
price level
SRAS
Pe
AD
Output (real GDP)
Ye
Price Level
1. Buyers are willing to
purchase all the units that
sellers are willing to supply at
LRAS
the current price level
SRAS100
P100
AD100
Output (real GDP)
YF
Price Level
LRAS
SRAS100
P100
AD100
2. The economy is at
full employment
Output (real GDP)
YF
3. The anticipated
price level is the actual
price level

Full employment
◦ No cyclical unemployment
◦ Actual unemployment rate = natural rate of
unemployment
◦ Actual output = potential output
No boom! No bust!




Happens when predictions about price level
are incorrect
Leads to Booms/Busts
Output can be higher or lower than potential
Employment can be higher or lower than full

Actual price level is higher than predicted

Short run:
◦ resource costs are low, output prices are high 
◦ producers earn higher than normal profits

Long run:
◦ contracts are renegotiated, resource prices rise 
◦ profits return to normal levels

Actual price level is lower than predicted

Short run:
◦ resource costs are high, output prices are low 
◦ producers earn lower than normal profits

Long run:
◦ contracts are renegotiated, resource prices fall 
◦ profits return to normal levels


Resource prices (wages, inputs) fixed in the
short run
Measured on x-axis
◦ Output, real GDP
◦ This moves inversely with unemployment
Flow of “ingredients” like labor services, raw
materials, machines, and other factors of
production
Demand
Supply
Price
Quantity
Businesses
Households
Wage
Employment

Labor makes up 70% of production costs in U.S.
Real Resource Price (Wage)
S
Households
supply labor and
other resources
Pr
D
Q
Businesses
demand labor and
other resources
Employment

Supply: positively sloped
◦ Higher resources prices (wage) give households
greater incentive to work for firms

Demand: negatively sloped
◦ Higher resource prices (wage) increase the cost of
production and make it less profitable
The flow of borrowing and lending
Market
Demand
Loanable
Funds
Borrowing by Domestic Saving (Lending) by
Interest
•Businesses
•Domestic Households Rate
•Government
•Net Capital Inflow

Supply
Price
Net capital inflow (of foreign capital);
◦ Saving (lending) by foreigners in U.S. institutions

Net capital outflow (of foreign capital);
◦ Borrowing by foreigners from U.S. institutions
Real Interest Rate
Lenders (savers)
supply loanable
S funds
r1
D
Q1
Borrowers demand
loanable funds
Loanable Funds

Supply: positively sloped
◦ Higher interest rates give an incentive to save (lend)
money

Demand: negatively sloped
◦ Higher interest rates reduce the quantity of
loanable funds demanded (borrowing)



Money interest rate – percentage of the amount
borrowed that must be paid to the lender in
addition to the repayment of the principle; nominal
interest rate
Real interest rate – the interest rate adjusted for
expected inflation, indicates change in purchasing
power
Inflationary premium – the expected rate of
inflation
Real interest rate  Money interest rate - inflationa ry premium
Flow of foreign currency
Market
Demand
Supply
Price
Foreign Exchange
Americans
Foreigners
Exchange Rate


Americans (use their dollars to) demand
foreign currencies
Foreigners supply foreign currencies (to be
exchanged into dollars)
Dollar Price of
Foreign Currency
S (Exports + Capital inflows)
P1
D (Imports + Capital outflows)
Q1
Quantity Foreign
Currency

Supply: positively sloped

Demand: negatively sloped
◦ As the dollar price of foreign currency rises, foreign
currency becomes more valuable
◦ Foreigners want to supply more of their currency to be
used to buy U.S. goods which have become cheaper
◦ U.S. exports rise
◦ As the dollar price of foreign currency rises, the dollar
becomes less valuable
◦ Domestic residents demand a smaller quantity of foreign
currency to buy foreign goods which have become more
expensive
◦ U.S. imports fall




Appreciation – an increase in the value of a
currency relative to foreign currencies,
increases the purchasing power
(move down the vertical axis when dollar appreciates)
Depreciation – a decrease in the value of a
currency relative to foreign currencies,
decreases the purchasing power
(move up the vertical axis when dollar depreciates)
Imports  Capital Outflow  Exports  Capital Inflow

Imports - Exports  Capital Inflow - capital outflow

Trade Deficit
◦ Imports > Exports
◦ Net Capital Inflow

Trade Surplus
◦ Exports > Imports
◦ Net Capital Outflow


Not necessarily “bad”
Causes
◦ High interest rates
 Federal government budget deficits 
 Good investment opportunities domestically 
◦ Currency manipulation??
 Foreign country’s gov’t increases supply of foreign
currency by purchasing U.S. financial assets
 Causes U.S. currency to appreciate



Describe the four key macroeconomic
markets
Examine the relationship between the general
price level and the amount of goods and
services demanded.
Examine the relationship between the general
price level and the amount of goods and
services supplied in the short-run and longrun.