Slide Show #10Slide Show #10AGEC 430

Macroeconomics of Agriculture

Spring 2010

Handout #18Handout #18

The Big 5 Macro VariablesThe Big 5 Macro Variables

There are 5 key variables linking the food and fiber system with the general economy.

They are:1. Rate of inflation2. Rate of interest3. Rate of unemployment4. Rate of growth in GDP 5. Rate of foreign exchange

The Big 5 Macro VariablesThe Big 5 Macro Variables

1. Rate of inflation – affects prices for farm inputs in the short run and interest rates in the longer run.

2. Rate of interest – affects farm interest expenses and farm land values.

3. Rate of unemployment – affects off-farm income of farm operator families, an important source of internal equity capital for many farmers and ranchers.

4. Rate of growth in GDP – affects domestic demand for agricultural products (remember the income elasticity of demand.

5. Rate of foreign exchange – reflects the value of the dollar relative to client nation currencies and hence the export demand for agricultural products.

Handout #19Handout #19

ie

MD MS

QM

Substituting equations 1 and2 into equation 3 and solving for the interest rate “i”

Substituting equations 1 and2 into equation 3 and solving for the interest rate “i”

A partial equilibrium focusingon the money market. As “Y” changes, it affects the rate of interest or “i”.

A partial equilibrium focusingon the money market. As “Y” changes, it affects the rate of interest or “i”.

AD AS

Pe

Ye

Substituting equations 6, 7 and 8 into equa-tion 9 and solving for “Y”…

Substituting equations 6, 7 and 8 into equa-tion 9 and solving for “Y”…

Savings, measured by S in this equation 13, is the “S” in the IS curve.

Savings, measured by S in this equation 13, is the “S” in the IS curve.

A partial equilibrium focusing on the product market. As the rate of interest “I” changes, aggregate demand “Y” changes.

A partial equilibrium focusing on the product market. As the rate of interest “I” changes, aggregate demand “Y” changes.

A general equilibrium for both the money and product market. This captures the only interest rate and level of GDP that satisfies both markets.

A general equilibrium for both the money and product market. This captures the only interest rate and level of GDP that satisfies both markets.

Expansionary Expansionary MonetaryMonetary

PolicyPolicy

Expansionary Expansionary MonetaryMonetary

PolicyPolicy

Given Y and i, you can solve for investment and consumption expendituresGiven Y and i, you can solve for investment and consumption expenditures

Expansionary Expansionary FiscalFiscalPolicyPolicy

Expansionary Expansionary FiscalFiscalPolicyPolicy

The intersection of the IS and LM curves not only gives us the general equilibrium in the money and aggregate product markets, but it also gives us the general price level in the economy (i.e., CPI).

The intersection of the IS and LM curves not only gives us the general equilibrium in the money and aggregate product markets, but it also gives us the general price level in the economy (i.e., CPI).

Expansionary monetary Expansionary monetary policypolicy, for example, would shift the LM curve to the right. Lower interest rates would stimulate investment and shift the aggregate demand curve to the right. We saw this presented earlier in Handout #16, but not in this general equilibrium context.

Expansionary monetary Expansionary monetary policypolicy, for example, would shift the LM curve to the right. Lower interest rates would stimulate investment and shift the aggregate demand curve to the right. We saw this presented earlier in Handout #16, but not in this general equilibrium context.

Macro-Market-MicroMacro-Market-Micro

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LE LMAX

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%∆PYPOT

Macro-Market-MicroOverview

Macro-Market-MicroOverview

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Wheat MarketWheat Market

Dw Sw

Pwe

Qwe

Wheat ProducerWheat Producer

MC

PweMR

qwe

AC

Implications for a Commodity Market and Individual Producer

Profit AnalysisProfit Analysis

MC

Pwe MR

qwe

AC

Average profit = MR – AC at qwe (distance between red and blue dots)Total profit = average profit times qwe (shaded area)

Average profit = MR – AC at qwe (distance between red and blue dots)Total profit = average profit times qwe (shaded area)

Expansionary Expansionary Monetary PolicyMonetary Policy

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Macro-Market-MicroOverview

Macro-Market-MicroOverview

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Step 1: Increase in the money supply shifts the LM curve to the right. Interest rates fall, suggesting an increase in invest-ment expenditures.

Step 1: Increase in the money supply shifts the LM curve to the right. Interest rates fall, suggesting an increase in invest-ment expenditures.

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Step 2: Aggregate demand increases, pulling up the general price level, and thus requires addition production.

Step 2: Aggregate demand increases, pulling up the general price level, and thus requires addition production.

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Step 3: The increased production requires additional labor, shifting the labor demand curve to the right and pushing up wages rates.

Step 3: The increased production requires additional labor, shifting the labor demand curve to the right and pushing up wages rates.

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Step 4: The decline in unemployment rate and presence of both demand pull and cost push inflation results in a movement down the Phillips curve.

Step 4: The decline in unemployment rate and presence of both demand pull and cost push inflation results in a movement down the Phillips curve.

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Wheat MarketWheat Market

Dw Sw

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5

One of the factors that shifts the demand curve for a commodity is disposable income. This not only shifts the aggregate demand curve for all goods and services but intermediate goods like wheat (step 5). This increases the price of the commodity.

One of the factors that shifts the demand curve for a commodity is disposable income. This not only shifts the aggregate demand curve for all goods and services but intermediate goods like wheat (step 5). This increases the price of the commodity.

Wheat MarketWheat Market

Dw Sw

PWe

QWe

Wheat ProducerWheat Producer

MC

PWeMR

qwe

AC

5 6

The increase in the price of the commodity means that the price that price takers like our wheat producer rises (step 6). Average profit rises (spread between green dots now instead of yellow dots). And more is supplied, increasing revenue and profit since qwe is greater.

The increase in the price of the commodity means that the price that price takers like our wheat producer rises (step 6). Average profit rises (spread between green dots now instead of yellow dots). And more is supplied, increasing revenue and profit since qwe is greater.

Farm Balance Sheet: 1/Current assets Up Current liabilities Up (accrued taxes)Land values 2/ Up Fixed liabilities No changeFixed assets No change Net worth or equity UpTotal assets Up Total debt and equity Up

1/ Assumes a current market value balance sheet.2/ Capitalized land values rise due to higher farm income.3/ Reflects assumption that taxes paid on last year’s income.

Farm Income Statement:Farm revenue UpFarm expenses Up slightlyFarm taxable income Up Income taxes 3/ No change Net farm income Up

Farm Income Statement:Farm revenue UpFarm expenses Up slightlyFarm taxable income Up Income taxes 3/ No change Net farm income Up

Wheat ProducerWheat Producer

MC

PWeMR

qwe

AC

6

The annual change in equity = retained earnings + net asset appreciationThe annual change in equity = retained earnings + net asset appreciation

Expansionary Expansionary Fiscal PolicyFiscal Policy

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%∆PYPOT

Macro-Market-MicroOverview

Macro-Market-MicroOverview

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Step 1: A cut in the income tax rate shifts the IS curve to the right. Interest rates rise, but the tax cut suggests an increase in consumption expenditures.

Step 1: A cut in the income tax rate shifts the IS curve to the right. Interest rates rise, but the tax cut suggests an increase in consumption expenditures.

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Step 2: Aggregate demand increases, pulling up the general price level, and thus requires addition production.

Step 2: Aggregate demand increases, pulling up the general price level, and thus requires addition production.

2

LS

wr

LE

UR

%∆P

LD

Step 3: The increased production requires additional labor, shifting the labor demand curve to the right and pushing up wages rates.

Step 3: The increased production requires additional labor, shifting the labor demand curve to the right and pushing up wages rates.

3

LS

wr

LE

UR

%∆P

LD

Step 4: The decline in unemployment rate and presence of both demand pull and cost push inflation results in a movement down the Phillips curve.

Step 4: The decline in unemployment rate and presence of both demand pull and cost push inflation results in a movement down the Phillips curve.

4

Wheat MarketWheat Market

Dw Sw

PWe

QWe

5

One of the factors that shifts the demand curve for a commodity is disposable income. This not only shifts the aggregate demand curve for all goods and services but intermediate goods like wheat (step 5). This increases the price of the commodity.

One of the factors that shifts the demand curve for a commodity is disposable income. This not only shifts the aggregate demand curve for all goods and services but intermediate goods like wheat (step 5). This increases the price of the commodity.

Wheat MarketWheat Market

Dw Sw

PWe

QWe

Wheat ProducerWheat Producer

MC

PWeMR

qwe

AC

5 6

The increase in the price of the commodity means that the price that price takers like our wheat producer rises (step 6). Average profit rises (spread between green dots now instead of yellow dots). And more is supplied, increasing revenue and profit since qwe is greater.

The increase in the price of the commodity means that the price that price takers like our wheat producer rises (step 6). Average profit rises (spread between green dots now instead of yellow dots). And more is supplied, increasing revenue and profit since qwe is greater.

Farm Balance Sheet: 1/Current assets Up Current liabilities Up (accrued taxes)Land values 2/ Up Fixed liabilities No changeFixed assets No change Net worth or equity UpTotal assets Up Total debt and equity Up

1/ Assumes a current market value balance sheet.2/ Capitalized land values rise due to higher farm income.3/ Reflects assumption that taxes paid on last year’s income.

Farm Income Statement:Farm revenue UpFarm expenses Up slightlyFarm taxable income Up Income taxes 3/ No change Net farm income Up

Farm Income Statement:Farm revenue UpFarm expenses Up slightlyFarm taxable income Up Income taxes 3/ No change Net farm income Up

Wheat ProducerWheat Producer

MC

PWeMR

qwe

AC

6

The annual change in equity = retained earnings + net asset appreciationThe annual change in equity = retained earnings + net asset appreciation

Summary CommentsSummary CommentsContractionary policy actions will reverse the

conclusions shown in this slide show.Know the four combinations of gaps and macro

policy in Handouts #16 and #17 (also see Slide Show #9). One will be on exam #2, being worth 20 points.

Be able to extend your analysis to the market and producer level illustrated in this slide show. This follow up may be on exam #2, and maybe worth another 5-10 points.