macroeconomic fundamentals 1.aggregate demand product market equilibrium 2.aggregate money market...
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Macroeconomic Macroeconomic Fundamentals Fundamentals
1.1. Aggregate demand product Aggregate demand product market equilibriummarket equilibrium
2.2. Aggregate money marketAggregate money market3.3. General equilibriumGeneral equilibrium
Above average global GDP growth Above average global GDP growth rates in 6 of last 8 yearsrates 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: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.
LMi3
i2
i1
Y1 Y2 Y3
Equilibrium in the Money MarketEquilibrium in the Money Market
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iE
MS
M
MD
Page 98
Inte
rest
Rat
e
Quantity of Money Gross Domestic Product
Definition of LM: Definition of LM: L L represents the demand for liquidity and MM represents the quantity of moneyAt all points along the LM curveLM curve, the demand for money equals supply.
Definition of LM: Definition of LM: L L represents the demand for liquidity and MM represents the quantity of moneyAt all points along the LM curveLM curve, the demand for money equals supply.
i3
i2
i1
Y3 Y2 Y1
IS
Product Market EquilibriumProduct Market Equilibrium
PE
ASAD
YE YPOT
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Gen
eral
Pric
e Le
vel
Gross Domestic Product Gross Domestic Product
Page 97
Definition of IS: Definition of IS: I I represents the investment spending and SS represents savings.At all points along the IS curveIS curve, investment equals savings.
Definition of IS: Definition of IS: I I represents the investment spending and SS represents savings.At all points along the IS curveIS curve, investment equals savings.
AS
YPOT
Gen
eral
Pric
e Le
vel
Gross Domestic Product
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Potential GDP in the current yearin the current year
Depressionrange
Normalrange
Classicalrange
Three Ranges of Aggregate SR Supply CurveThree Ranges of Aggregate SR Supply Curve
Note: The aggregate production aggregate production functionfunction for the general economy is:
Y = f(L,K) where L is the employed labor force, and K is the capital stock.
∆PE
ASAD
∆YE YPOT
Gen
eral
Pric
e Le
vel
Gross Domestic Product
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∆PE
ASAD
∆YE YPOT
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 (∆PE/PE).
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 (∆PE/PE).
Elasticity of SR Aggregate Supply CurveElasticity of SR Aggregate Supply Curve
PE
ASAD
ISLM
YE YPOT
iE
YE
iE
MS
M
MD
Page 97
General Equilibrium General Equilibrium in the money and in the money and product marketsproduct markets
General Equilibrium General Equilibrium in the money and in the money and product marketsproduct markets
Inte
rest
Rat
e
Gen
eral
Pric
e Le
vel
Gross Domestic Product
Quantity of Money
∆WRE
∆LE LMAX
LD
LS
Equilibrium in Labor MarketEquilibrium in Labor Market
∆PE
AS
AD
∆YE YPOT
Product Market Labor Market
Gen
eral
Pric
e Le
vel
Gross Domestic Product EmploymentW
age
Rat
e
Page 98Page 97
The aggregate demand for goods and services in the product marketdrives the demand for labor in the nation’s labor market.
The aggregate demand for goods and services in the product marketdrives the demand for labor in the nation’s labor market.
UR
INF
Phillips Curve Tradeoff in Short RunPhillips Curve Tradeoff in Short Run
UR
INF
Expansionary Policy Impact Contractionary Policy Impact
Une
mpl
oym
ent
Rat
e
Inflation Rate Inflation Rate
This curve initially proposed by the English economist William Phillipstracks the short run tradeoffshort run tradeoff between unemployment and inflation.
This curve initially proposed by the English economist William Phillipstracks the short run tradeoffshort run tradeoff between unemployment and inflation.
ISLM
LM*
i
Y
ISLM
Y
IS*
i
Inte
rest
Rat
e
Gross Domestic Product
Page 95
Gross Domestic Product
Page 96
Hint: Contractionary monetary and fiscal policy actions have theexact opposite effects of expansionary policy actions.
Hint: Contractionary monetary and fiscal policy actions have theexact opposite effects of expansionary policy actions.
Expansionary Monetary policyAction: increase money supply
Expansionary Monetary policyAction: increase money supply
Expansionary Fiscal policyAction: cut tax rates and/or raise government spending
Expansionary Fiscal policyAction: cut tax rates and/or raise government spending
AD*
ISLM
LM*
i
YE
Expansionary Monetary policyAction: increase money supply
Expansionary Monetary policyAction: increase money supply
∆PE
ASAD
∆YE YPOT
∆WRE
∆LE LMAX
LD*LS
Inte
rest
Rat
e
Gen
eral
Pric
e Le
vel
Wag
e R
ate
Gross Domestic Product Employment
LD
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.
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.
ISLM
YE
Expansionary Fiscal policyAction: cut tax rates or raise
government spending
Expansionary Fiscal policyAction: cut tax rates or raise
government spending
IS*
∆PE
ASAD
∆YE YPOT
∆WRE
∆LE LMAX
LD
LS
i
Inte
rest
Rat
eG
ener
al P
rice
Leve
l
Wag
e R
ate
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.
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 GapsFull Employment and GDP Gaps
PE
ASAD
YE YPOT
YFE
Recessionary GDP Gap
Use expansionary policy toUse expansionary policy toeliminate SR recessionary gap:eliminate SR recessionary gap:1. Lower interest rates2. Cut taxes3. Increase government spending
PE
ASAD
YE YPOT
Full Employment and GDP GapsFull Employment and GDP Gaps
PE
ASAD
YE YPOT
YFE
Recessionary GDP Gap Inflationary GDP Gap
YFE
Use expansionary policy toUse expansionary policy toeliminate SR recessionary gap:eliminate SR recessionary gap:1. Lower interest rates2. Cut taxes3. Increase government spending
Use contractionary policy toUse contractionary policy toeliminate SR inflationary gap:eliminate SR inflationary gap:1. Raise interest rates2. Raise taxes3. Decrease government spending
“Big 5” macroEconomicvariables
ExpansionaryExpansionaryMonetaryMonetary
PolicyPolicy
ContractionaryContractionaryMonetary PolicyMonetary Policy
ExpansionaryExpansionaryFiscalFiscalPolicyPolicy
ContractionaryContractionaryFiscalFiscalPolicyPolicy
Interest rate LowerLower HigherHigher HigherHigher LowerLower
GDP growth rate HigherHigher LowerLower HigherHigher LowerLower
Unemployment rate LowerLower HigherHigher LowerLower HigherHigher
Inflation rate HigherHigher LowerLower HigherHigher LowerLower
Exchange rate LowerLower HigherHigher HigherHigher LowerLower
Impact of macroeconomic policy on five variables important toImpact of macroeconomic policy on five variables important tothe nation’s food and fiber Industrythe nation’s food and fiber Industry
Impact of macroeconomic policy on five variables important toImpact of macroeconomic policy on five variables important tothe nation’s food and fiber Industrythe nation’s food and fiber Industry
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Policy Impacts on Macro EconomyPolicy Impacts on Macro Economy
Macro – Market – MicroMacro – Market – Micro
Page 102Note: This does not occur instantaneously.Note: This does not occur instantaneously.
Page 103Note: This does not occur instantaneously.Note: This does not occur instantaneously.
Farm sectorvariables
ExpansionaryExpansionaryMonetaryMonetary
PolicyPolicy
ContractionaryContractionaryMonetary PolicyMonetary Policy
ExpansionaryExpansionaryFiscalFiscalPolicyPolicy
ContractionaryContractionaryFiscalFiscalPolicyPolicy
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 toImpact of macroeconomic policy on five variables important tothe nation’s farm sectorthe nation’s farm sector
Impact of macroeconomic policy on five variables important toImpact of macroeconomic policy on five variables important tothe nation’s farm sectorthe nation’s farm sector
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Policy Impacts on the Farm SectorPolicy Impacts on the Farm Sector
What is Next?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?Any Questions?