Macroeconomic Fundamentals Aggregate demand product market ...

oppositemincedManagement

Oct 28, 2013 (3 years and 11 months ago)

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Macroeconomic
Fundamentals

1.
Aggregate demand product
market equilibrium

2.
Aggregate money market

3.
General equilibrium

Above average global GDP growth
rates in 6 of last 8 years

1988
-
97

Ave.

1998

1999

2000

2001

2002

2003

2004

2005

2006

World

3.4

2.8

3.7

4.9

2.6

3.1

4.1

5.3

4.9

5.1

Africa

2.3

2.8

2.7

3.1

4.2

3.6

4.6

5.5

5.4

5.4

Central and Eastern
Europe

0.9

2.9

0.7

5.1

0.3

4.5

4.7

6.5

5.4

5.3

Middle East

4.0

3.7

1.8

5.3

3.0

4.1

6.4

5.5

5.7

5.8

China

9.9

7.8

7.1

8.4

8.3

9.1

10.0

10.1

10.2

10.0

India

6.0

5.9

6.9

5.3

4.1

4.3

7.2

8.0

8.5

8.3

Other emerging
market and
developing countries


4.1


3.0


4.1


6.1


4.4


5.1


6.7


7.7


7.4


7.3

United States

3.0

4.2

4.5

3.7

0.8

1.6

2.5

3.9

3.2

3.4

Sources: US Department of Commerce and International Monetary Fund.

Components of Aggregate Demand:


Aggregate demand is defined as the sum of consumption
spending (C), investment spending (I), Government
spending (G), and net exports (X
-
M); X represents
exports and M represents imports.


Aggregate demand, referred to as Gross domestic
product or GDP, is therefore given by:


AD = GDP = C + I + G + X


M


The economy is said to be in general equilibrium when
the money, labor and product markets are all in
equilibrium. Focus here is on the short run.

LM

i
3


i
2


i
1

Y
1

Y
2

Y
3

Equilibrium in the Money Market

Page 93

i
E

M
S

M

M
D

Page 98

Interest Rate

Quantity of Money

Gross Domestic Product

Definition of LM:

L
represents the demand for liquidity and
M

represents the quantity of money

At all points along the
LM curve
, the demand for money equals supply.

i
3


i
2


i
1

Y
3

Y
2

Y
1

IS

Product Market Equilibrium

P
E

AS

AD

Y
E

Y
POT

Page 94

General Price Level

Gross Domestic Product

Gross Domestic Product

Page 97

Definition of IS:

I
represents the investment spending and
S

represents savings.

At all points along the
IS curve
, investment equals savings.

AS


Y
POT

General Price Level

Gross Domestic Product

Page 97

Potential GDP
in the current year

Depression

range

Normal

range

Classical

range

Three Ranges of Aggregate SR Supply Curve

Note: The
aggregate production
function

for the general economy is:


Y = f(L,K) where L is the employed labor
force, and K is the capital stock.


P
E

AS

AD


Y
E

Y
POT

General Price Level

Gross Domestic Product

Page 97


P
E

AS

AD


Y
E

Y
POT

Gross Domestic Product

Page 97

Elasticity of the short run aggregate supply curve in the normal range
will help determine the rate of demand pull inflation in the economy,
given by the percent change in the general price level or (∆P
E
/P
E
).

Elasticity of SR Aggregate Supply Curve

P
E

AS

AD

IS

LM

Y
E

Y
POT

i
E

Y
E

i
E

M
S

M

M
D

Page 97

General Equilibrium
in the money and
product markets

Interest Rate

General Price Level

Gross Domestic Product

Quantity of Money


WR
E


L
E

L
MAX

L
D

L
S

Equilibrium in Labor Market


P
E

AS

AD


Y
E
Y
POT

Product Market

Labor Market

General Price Level

Gross Domestic Product

Employment

Wage Rate

Page 98

Page 97

The aggregate demand for goods and services in the product market

drives the demand for labor in the nation’s labor market.

UR

INF

Phillips Curve Tradeoff in Short Run

UR

INF

Expansionary Policy Impact

Contractionary Policy Impact

Unemployment Rate

Inflation Rate

Inflation Rate

This curve initially proposed by the English economist William Phillips

tracks the
short run tradeoff

between unemployment and inflation.

IS

LM

LM*


i


Y

IS

LM


Y

IS*


i

Interest Rate

Gross Domestic Product

Page 95

Gross Domestic Product

Page 96

Hint: Contractionary monetary and fiscal policy actions have the

exact opposite effects of expansionary policy actions.

Expansionary Monetary policy

Action: increase money supply

Expansionary Fiscal policy

Action: cut tax rates and/or

raise government spending

AD*

IS

LM

LM*


i


Y
E

Expansionary Monetary policy

Action: increase money supply


P
E

AS

AD


Y
E

Y
POT


WR
E


L
E

L
MAX

L
D
*

L
S

Interest Rate

General Price Level

Wage Rate

Gross Domestic Product

Employment

L
D

Expansionary monetary policy
lowers interest rates, stimulates
investment spending, increases
aggregate demand for goods
and services, can increase the
general price level, increases
the need for additional labor to
produce additional goods and
services, and can increase the
wage rates. Does not occur
instantaneously.

IS

LM


Y
E

Expansionary Fiscal policy

Action: cut tax rates or raise
government spending

IS*


P
E

AS

AD


Y
E

Y
POT


WR
E


L
E

L
MAX

L
D

L
S


i

Interest Rate

General Price Level

Wage Rate

Gross Domestic Product

Employment

Expansionary fiscal policy leads
to government borrowing, raising
interest rates, but stimulates
aggregate demand for goods and
services, can increase the
general price level, increases the
need for additional labor to
produce additional goods and
services, and can increase the
wage rates. Does not occur
instantaneously.

Full Employment and GDP Gaps

P
E

AS

AD

Y
E

Y
POT

Y
FE

Recessionary GDP Gap

Use expansionary policy to

eliminate SR recessionary gap:

1. Lower interest rates

2. Cut taxes

3. Increase government spending

P
E

AS

AD

Y
E

Y
POT

Full Employment and GDP Gaps

P
E

AS

AD

Y
E

Y
POT

Y
FE

Recessionary GDP Gap

Inflationary GDP Gap

Y
FE

Use expansionary policy to

eliminate SR recessionary gap:

1. Lower interest rates

2. Cut taxes

3. Increase government spending

Use contractionary policy to

eliminate SR inflationary gap:

1. Raise interest rates

2. Raise taxes

3. Decrease government spending

“Big 5” macro

Economic

variables

Expansionary

Monetary

Policy

Contractionary

Monetary Policy

Expansionary

Fiscal

Policy

Contractionary

Fiscal

Policy

Interest rate

Lower

Higher

Higher

Lower

GDP growth rate

Higher

Lower

Higher

Lower

Unemployment rate

Lower

Higher

Lower

Higher

Inflation rate

Higher

Lower

Higher

Lower

Exchange rate

Lower

Higher

Higher

Lower

Impact of macroeconomic policy on five variables important to

the nation’s food and fiber Industry

Page 101

Policy Impacts on Macro Economy

Macro


Market


Micro

Page 102

Note: This does not occur instantaneously.

Page 103

Note: This does not occur instantaneously.

Farm sector

variables

Expansionary

Monetary

Policy

Contractionary

Monetary Policy

Expansionary

Fiscal

Policy

Contractionary

Fiscal

Policy

Farm revenue

Higher

Lower

Higher

Lower

Farm expenses

Higher

Lower

Higher

Lower

Net farm income

Higher

Lower

Higher

Lower

Farm land values

Higher

Lower

Higher

Lower

Exports

Higher

Lower

Lower

Higher

Impact of macroeconomic policy on five variables important to

the nation’s farm sector

Page 104

Policy Impacts on the Farm Sector

What is Next?


We have covered the
topic of market
equilibrium for a specific
commodity.


We have also covered
the topic of general
equilibrium and GDP
gaps.


Let’s now look at policy
actions we would expect
from policymakers and
their impact on individual
markets at the economy
level.

Any Questions?