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Economics: Theory Through Applications
19-1
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Chapter 19
The Interconnected Economy
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Learning Objectives
•
What factors underlie the demand for housing?
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What factors underlie the supply of housing?
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What determines the amount of housing traded and the price of housing?
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What are exogenous and endogenous events?
•
How does the equilibrium of a market respond to changes in exogenous
variables?
•
What is comparative statics and how is it used?
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Learning Objectives
•
What is the credit market and what determines the interest rate?
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What is the labor market and what determines the real wage?
•
What is the foreign currency market and what determines the exchange
rate?
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How are the markets for goods, labor, credit and foreign currency linked?
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How do we use those links to understand the crisis that began in 2008?
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Figure 19.1 - The Market Demand for Houses
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Figure 19.2 - A Shift in the Market Demand
Curve
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Figure 19.3 - The Market Supply of Houses
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Figure 19.4 - A Shift in Supply of Houses
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Figure 19.5 - Market Equilibrium
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Table 19.1 - Market Equilibrium: An Example
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Figure 19.6 - A Decrease in Demand for
Housing
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The Credit Market
repayment amount
 1  nominal interest rate
loan amount
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Figure 19.7 - A Market for $1,000 Loans
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Figure 19.8 - A Reduction in Supply in the
Mortgage Market
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Nominal Interest Rates and Real Interest
Rates
real interest rate  nominal interest rate – inflation rate
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Figure 19.9 - The Aggregate Credit Market
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Figure 19.10 - Equilibrium in the Market for
Construction Workers
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Figure 19.11 - A Decrease in Demand for
Construction Workers
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Figure 19.12 - Equilibrium in the Labor
Market
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Figure 19.13 - Equilibrium in the Foreign Exchange
Market Where Dollars and Euros Are Exchanged
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Figure 19.14 - Comparative Statics in the
Euro Market
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Figure 19.15 - Foreign Exchange Market
Equilibrium
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Figure 19.16 - The Circular Flow of Income
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Figure 19.17
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Figure 19.18
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Figure 19.19 - A Decrease in Demand for
Labor
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Figure 19.20
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Figure 19.21 - A Decrease in Demand for
Shoeshines
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Trade Flows and a Shift in the Demand For
Foreign Exchange
borrowing from abroad  imports – exports
or
lending to abroad  exports  imports
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Key Terms
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Supply and demand: Supply and demand is a framework to explain and
predict the equilibrium price and equilibrium quantity of a good
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Competitive market: A market is said to be competitive, or more
precisely to exhibit perfect competition, when there are many buyers and
sellers and the goods produced by the sellers are perfect substitutes
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Market demand curve: The number of units of a good or a service
demanded at each price
•
Market supply curve: The number of units of a good or a service supplied
at each price
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Key Terms
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Equilibrium price: A price such that the quantity supplied equals the
quantity demanded
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Equilibrium quantity: The quantity supplied and demanded at the
equilibrium price
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Key Terms
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Exogenous: Something that comes from outside a model and is not
explained in our analysis.
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Endogenous: Something that is explained within our analysis
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Comparative statics: Comparative statics is a technique that describes
how market equilibrium prices and quantities depend on exogenous events
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Nominal interest rate: The nominal interest rate is the number of
additional dollars that must be repaid for every dollar that is borrowed
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Real interest rate: The rate of return specified in terms of goods not
money
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Key Terms
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Fisher equation: A formula for converting from nominal interest rates to
real interest rates: the real interest rate equals the nominal interest rate
minus the inflation rate
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Credit market: The credit market brings together suppliers of credit, such
as households who are saving, and demanders of credit, such as businesses
and households who need to borrow.
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Real wage: The real wage is the relative price of labor in terms of
consumption goods
– It equals the nominal wage (the wage in dollars) divided by the price level
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Key Terms
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Labor market: The labor market is the market which brings together
households who supply labor services and firms who demand labor as an
input into the production process
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Foreign exchange market: A foreign exchange market is where one
currency is traded for another
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Nominal exchange rate: The nominal exchange rate is the price of one
currency in terms of another
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Current account balance: The current account balance is the difference
between the value of exports and imports of goods and services
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Net exports: Net exports equals exports minus imports
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Key Takeaways
•
The primary factor influencing the demand for housing is the price of
housing
– By the law of demand, as the price of housing falls, the quantity of housing
demanded increases
– The demand for housing also depends on wealth of households, their current
income and interest rates
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The primary factor influencing the supply of housing is the price of
housing
– As the price increases, the quantity supplied increases as well
– The supply of housing is shifted by changes in the price of inputs by changes in
technology
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Key Takeaways
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The quantity and price of housing traded is determined by the equilibrium
of the housing market
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Exogenous variables are determined from outside a framework, while
endogenous variables are determined within the framework
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Changes in exogenous variables lead to shifts in market supply and/or
market demand curves
– These shifts in supply and demand then lead to changes in quantities and
prices
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Key Takeaways
•
Comparative statics is a technique to describe how changes in exogenous
variables influence equilibrium quantities and prices
– It is used to answer questions about how markets respond to changes in
exogenous variables
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The credit market brings together the suppliers (households) of credit
with those who are demanding credit (other households, firms and the
government)
– The interest rate adjusts to attain a market equilibrium
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Key Takeaways
•
The labor market is where labor services are traded
– Households supply labor and firms demand labor
– The real wage adjusts to attain a market equilibrium
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The foreign exchange market brings together demanders and suppliers of
foreign currency
– The exchange rate, which is the price of one currency in terms of another,
adjusts to attain a market equilibrium
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Key Takeaways
•
Markets are linked because supply and demand in one market will
generally depend on the prices in other markets
– The circular flow of income illustrates some of these connections across
markets
•
Although the crisis in 2008 may have started in the housing market, it did
not end there
– Instead, the crisis impacted markets for labor, credit, and foreign exchange
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