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Macro-Market-Micro AGEC 430 Macroeconomics of Agriculture Spring 2010 Let’s Look at a Simplified Closed Macroeconomy Consumption Ce Ac Y-T Investment Consumption Ce ie Ac Y-T Ie Ai Investment Consumption Aggregate Product Ad Ce ie As Pe Ac Y-T Ie Ai Ye Ypot Remember that aggregate demand includes both consumption and investment expenditures as well as government spending and net exports. Investment Consumption Aggregate Product Ad Ce ie As Pe Ac Y-T Ie Labor Market Ld Ls wre Le Lmax Ai Ye Ypot Investment Consumption Aggregate Product Ad Ce ie As Pe Ac Y-T Ie Labor Market Ld Phillips Curve Ls UR wre Le Ai Lmax %ΔP Ye Ypot Investment Consumption Aggregate Product Ad Ce ie As Pe Ac Y-T Ie Labor Market Ld Ye Ypot Phillips Curve Ls These relationships represent a simplified “real” macroeconomy UR wre Le Ai Lmax %ΔP Policy Linkages Money Market Md Ms ie Qm Policy Linkages Money Market Md Tax Revenue Ms T ie h Qm Yt-1 Policy Linkages Money Market Md Tax Revenue Budget Deficit Ms G ie Qm T T h h Yt-1 Yt-1 Policy Linkages Money Market Md Tax Revenue Budget Deficit Ms G ie Qm National debt NDt = NDt-1 + Gt - Tt T T h h Yt-1 Yt-1 Macro to Market Linkage Aggregate Product Ad Wheat Market Dw As Pwe Pe Ye Ypot Qwe Sw Market to Micro Linkage Aggregate Product Ad Wheat Market Dw As Ye Ypot Sw MC MR Pwe Pwe Pe Wheat Producer Qwe AC qwe Market to Micro Linkage Aggregate Product Ad Wheat Market Dw As Sw Ye Ypot MC MR Pwe Pwe Pe Wheat Producer Qwe Is the wheat producer making a profit? AC qwe Market to Micro Linkage Wheat Producer Average profit is the difference between MR and AC at qwe MC MR Pwe AC qwe Is the wheat producer making a profit? Total profit therefore is equal to average profit times qwe Market to Micro Linkage Wheat Producer Average profit is the difference between MR and AC at qwe MC MR Pwe AC qwe Is the wheat producer making a profit? Total profit therefore is equal to average profit times qwe Any Questions? Effects of Expansionary Monetary Policy Money Market Md Ms Action: The Federal Reserve buys government bonds. ie Qm Money Market Md Ms ie Qm Effect: This action expands the money supply, shifting the money supply curve to the right, and lowers the market interest rate. Investment ie 1 Ie Ai Let’s look at the effect on the “real” economy. Investment Aggregate Product As Ad 2 ie 1 Ie Ai Pe Ye Ypot Investment Aggregate Product As Ad 2 ie 1 Consumption Ce Pe Ac Ie Ai Ye Ypot We defined inflation as follows: %ΔP = a1(%Δwr) + a2(Y / YPOT) Is there demand pull inflation in this economy? Why? 3 Y-T Investment Aggregate Product As Ad 2 ie Consumption Ce Pe 1 Ac Ie Ye Ypot Ai 3 Y-T Labor Market Ld Ls 4 We defined inflation as follows: wre %ΔP = a1(%Δwr) + a2(Y / YPOT) Le Lmax Is there cost push inflation in this economy? Why? What Does The Phillips Curve Therefore Look Like in This Economy? Phillips Curve ??? UR %ΔP Phillips Curve UR Phillips Curve UR %ΔP Since no inflation possible %ΔP Thus we can ignore the Phillips Curve for now. Investment Aggregate Product As Ad 2 ie Consumption Ce Pe 1 Ac Ie Ye Ypot Ai Labor Market Ld Y-T Wheat Market Ls Dw Sw 5 4 PWe wre Le 3 Lmax QWe Increase in wages and disposable personal income increases the demand for wheat as long as the income elasticity > zero. Investment Aggregate Product As Ad 2 ie Consumption Ce Pe 1 Ac Ie Ye Ypot Ai Labor Market Ld Y-T Wheat Market Ls Dw 3 Wheat Producer Sw 5 6 MC 4 Le Lmax MR PWe PWe wre QWe AC qwe Impact on Farm Financial Statements Farm Income Statement: Farm revenue Farm expenses Farm taxable income Income taxes Net farm income Up Up slightly Up No change Up 6 MC MR PWe AC qwe Impact on Farm Financial Statements Farm Income Statement: Farm revenue Farm expenses Farm taxable income Income taxes Net farm income Up Up slightly Up No change Up Remember taxes assumed to be based on Yt-1 and not current income. Impact on Farm Financial Statements Farm Income Statement: Farm revenue Farm expenses Farm taxable income Income taxes Net farm income Up Up slightly Up No change Up Farm Balance Sheet: 1/ Current assets Up Land values 2/ Up Fixed assets No change Total assets Up Current liabilities Fixed liabilities Net worth Total debt and equity 1/ Assumes a current market value balance sheet. 2/ Capitalized land values rise due to higher farm income. Up (accrued taxes) No change Up Up Impact on Farm Financial Statements Farm Income Statement: Farm revenue Farm expenses Farm taxable income Income taxes Net farm income Up Up slightly Up No change Up Farm Balance Sheet: 1/ Current assets Up Land values 2/ Up Fixed assets No change Total assets Up Current liabilities Fixed liabilities Net worth Total debt and equity Up (accrued taxes) No change Up Up 1/ Assumes a current market value balance sheet. 2/ Capitalized land values fall due to lower farm income. Conclusion: Expansionary monetary policy good for farmers. Any Questions? Effects of Contractionary Fiscal Policy Tax Revenue Action: The government raises the income tax rate. T h Yt-1 Tax Revenue Budget Deficit Effect: Raises tax revenue and lowers the budget deficit in the short run since tax revenue based on last year’s income. G T T h h Yt-1 Yt-1 Consumption Ce Ac 1 Y-T Let’s look at the effect on the “real” Economy again. Investment Consumption Ce ie 2 Ac 1 Y-T Ie Ai Investment Consumption Aggregate Product As Ad Ce 3 ie 2 Ac 1 Y-T Ie Ai Pe Ye Ypot Investment Consumption Aggregate Product As Ad Ce 3 ie 2 Ac 1 Y-T Ie Labor Market Ld Ls 4 wre Le Lmax Ai Pe Ye Ypot Investment Consumption Aggregate Product As Ad Ce 3 ie 2 Ac 1 Y-T Ie Labor Market Ld Ai Ye Ypot Wheat Market Ls Dw Sw 5 4 PWe wre Le Pe Lmax QWe Decrease in wages and disposable personal income decreases the demand for wheat as long as the income elasticity > zero. Investment Consumption Aggregate Product As Ad Ce 3 ie 2 Ac 1 Y-T Ie Labor Market Ld Pe Ye Ypot Ai Wheat Market Ls Dw Sw 5 4 Wheat Producer PWe 6 MC PWe wre Le Lmax MR AC QWe qwe Impact on Farm Financial Statements Farm Income Statement: Farm revenue Farm expenses Farm taxable income Income taxes Net farm income Down Down slightly Down Down Down PWe 6 MC MR AC qwe Impact on Farm Financial Statements Farm Income Statement: Farm revenue Farm expenses Farm taxable income Income taxes Net farm income Down Down slightly Down Down Down Last year’s income taxed at a higher rate. Impact on Farm Financial Statements Farm Income Statement: Farm revenue Farm expenses Farm taxable income Income taxes Net farm income Down Down slightly Down Down Down Farm Balance Sheet: 1/ Current assets Down Land values 2/ Down Other assets No change Total assets Down Current liabilities Down (accrued taxes) Fixed liabilities No change Net worth Down Total debt and equity Down 1/ Assumes a current market value balance sheet. 2/ Capitalized land values fall due to lower farm income. Impact on Farm Financial Statements Farm Income Statement: Farm revenue Farm expenses Farm taxable income Income taxes Net farm income Down Down slightly Down Down Down Farm Balance Sheet: 1/ Current assets Down Land values 2/ Down Other assets No change Total assets Down Current liabilities Down (accrued taxes) Fixed liabilities No change Net worth Down Total debt and equity Down 1/ Assumes a current market value balance sheet. 2/ Capitalized land values fall due to lower farm income. Conclusion: Contractionary fiscal policy not good for farmers. Any Questions? Know These Relationships