PDF-Ch9 - 3/24/2010 Ch. 9 – Aggregate Supply & Demand...

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Unformatted text preview: 3/24/2010 Ch. 9 – Aggregate Supply & Demand & finding equilibrium in 4 major macro markets • More and more Red Box movie rentals keep cropping up in places such as Walmart and McDonalds, increasing the convenience of renting. Please use a S & D graph to show how these new type graph to show how these new type rentals rentals might impact P & Q in places such as Blockbuster movie rentals and Movie Gallery, less convenient. Ch. 9 – First, define 2 terms: • Fiscal Policy – Changes in government spending and taxes (including deficit spending or borrowing) – Carried out by the TREASURY TREASURY • Monetary Policy Ch. 9 – AS & AD & 4 Major Macro Markets 1. 2. 3. 4. Goods & Services Resources Loanable Funds Foreign Exchange – Changes in monetary policy – Carried out by the FEDERAL RESERVE FEDERAL How do these 4 markets interact? • Flow of Funds chart Ch. 9 – AS & AD & 4 Major Macro Markets Let’s start with the Goods and services market: 1 3/24/2010 What is Aggregate Demand? • We’re summing demand over all types of • • • spending (consumption, business, government and net exports) Therefore, it’s the sum of spending on all goods and services (GDP) AD is a broader measure than individual demand or demand for one industry AD is the relationship between 2 variables: For an economy, aggregate demand equals: 1. Consumption + investment + government spending + exports 2. Consumption + investment + (taxes – transfers) + (exports – imports) 3. Consumption + investment + 4. government spending (exports government spending + (exports – imports) Consumption + investment + government spending + (imports – exports) – The average price level – The quantity of goods & services desired What is the relationship between the APL and the QUANTITY of G & S demanded? (Real GDP)? • There is an inverse relationship (MA) Ceteris paribus, a decrease in the general level of prices in the U.S. will cause: 1. 2. 3. 4. 5. 6. 7. 8. ↑ U.S. exports ↑ U.S. imports AD curve to shift to the right AD curve to shift to the left ↑Aggregate QUANTITY demanded QUANTITY demanded ↓Aggregate QUANTITY demanded Purchasing Power of consumers to ↑ Purchasing Power of consumers to ↓ What are the four key markets in the AD/AS model? The Aggregate Demand curve indicates the relationship between: 1. Labor, Public Goods, Bonds, Stock 2. Goods & Services, Resources, Loanable 1. The real wage rate and the quantity of 3. 3. 4. Funds, Foreign Exchange Consumption, Investment, Government Consumption, Investment, Government Spending, Spending, Net Exports Food, Housing, Clothing, Automobiles 2. 3. 4. resources demanded by producers of goods and services. The average price level and the aggregate quantity of G & S demanded. Th The Natural Rate of Unemployment and the the demand for G & S when the economy is in LR equilibrium The interest rate and the amount of loanable funds demanded by borrowers. 2 3/24/2010 Aggregate Supply What is the relationship between the APL and the QUANTITY of G & S offered for sale (Real GDP)? • What is AS? • STOP!!!! With Aggregate SUPPLY, – Adding up all the things that businesses are willing and able to sell (& produce). All business services and goods offered for for sale. you always must distinguish between SR and LR – So there are TWO aggregate supply curves…..short run and long run – SR: Some factors are fixed – LR: ALL factors are variable (contracts expire and get renegotiated.) What is the relationship between the APL and the QUANTITY of G & S offered for sale (Real GDP)? • STOP!!!! With Aggregate SUPPLY, you always must distinguish between SR and LR Short Run Aggregate Supply curve APL SRAS 1. SR always deals with PROFIT….does this affect Profit? If so, HOW? 2. LR always think about CAPACITY. What are we ABLE to produce? What CAN we produce? Does this affect the PPC? Why is it upward sloping? • In the SR, most resource prices are Y = Real GDP Short Run Aggregate Supply curve FIXED – Negotiated contracts – Locked in rates – Renegotiate at end of year – Basically, resource prices change once a year. • What are profits? • PROFITS = TR – TC • If prices (APL) increase but COSTS are fixed, profits ↑ • Thus: ↑APL leads to ↑ Qs (pos. rela) APL SRAS Y = Real GDP 3 3/24/2010 But in the LR, there is NO relationship NO between APL and Qs in the long run LRAS curve: LRAS • WHY? IN LR, everything fully adjusts APL – If the APL is increasing by, say, 2%, that means all things are increasing by 2% • wages • Prices – – of goods sold of resources – If everything (price & cost) is increasing by the same %, you are no better off, no worse off PROFIT = TR – TC (nothing has changed) (% ∆) 0 = + 2% (-) +2% In other words, there is no relationship between APL and Qs in the long run • WHY? IN LR, everything fully adjusts • Resource prices are flexible, prices are flexible so a change in APL does not affect profits FE rate of O/P = NRU = Potential GDP LR – Capacity • Just think of the PPC – Anything that changes PPC is what also changes LRAS curve. • Also think of Business Cycle graph. – LRAS is analogous to Potential GDP GDP – LRAS is also analogous to being ON the PPC So what DOES influence LRAS? • Changes in Technology • More efficient use of resources (more educated • Y = Real GDP • But PPC & LRAS are NOT the same thing… – They describe the same output level – But PPC assumes fixed resources labor force) Basically, the same things that influence the PPC • ANYTHING BUT PRICES!!! What would generally cause business firms to expand output in the short run? short 1. An increase in wages and prices of other 2. 3. 4. resources An unexpected reduction in aggregate demand Higher profit margins as the result of an unexpected increase in prices of goods unexpected increase in prices of goods & services A proportional increase in the price of goods & services and the costs of producing them What would generally cause business firms to expand output in the long run? 1. Unions negotiating a new contract for higher wages over the next year. 2. An increase in technology 3. Higher profit margins as the result of an 4. unexpected increase in prices of goods unexpected increase in prices of goods & services An unexpected reduction in aggregate demand which reduces prices 4 3/24/2010 How do we find equilibrium in the G & S market? • Since we have both a SRAS and How do we find equilibrium in the How do we find equilibrium in the G & S market? market? LR (and SR) equilibrium in the G & S market: Pt. 2 (and APL • LRAS, we will have 2 equilibriums…both a SR and a LR When we are in LR equilibrium – Actual GDP = Potential GDP (about 3% GR) – Actual unemployment rate = NRU (about 5%) – All three curves intersect at the same place – LRAS, SRAS and AD are all equal LR (and SR) equilibrium = POTENTIAL GDP (and APL LRAS LRAS SRAS AD 1 2 3 SRAS AD Y = Real GDP 1 2 3 Y = Real GDP SR equilibrium does not always = LR equilibrium in the G&S market But SR equilibrium does not always have to = LR equilibrium in the G&S market AD could shift SRAS could shift Let’s take some examples: DECREASE in Aggregate Demand: APL LRAS SRAS At Pt. 1, Actual GDP Actual GDP < Potential Potential GDP Cyclical UnemployUnemployment is present AD1 Pt. 1 is below the below the trend trend line on the business cycle….and inside the PPC AD2 1 2 3 Y = Real GDP 5 3/24/2010 SR equilibrium does not always = LR equilibrium in the G&S market SR equilibrium does not always = LR equilibrium in the G&S market INCREASE in Aggregate Demand: INCREASE in Short Run Aggregate Supply: APL APL LRAS LRAS SRAS At Pt. 3, Actual GDP Actual GDP > Potential Potential GDP SRAS 1 AD2 NO Cyclical UnemployUnemployment is present AD1 1 2 3 Pt. 3 is above the above the trend trend line on the business cycle….and beyond the PPC DECREASE in Short Run Aggregate Supply: LRAS SRAS 2 NO Cyclical UnemployUnemployment is present Y = Real GDP SR equilibrium does not always = LR equilibrium in the G&S market APL At Pt. 3, Actual GDP Actual GDP > Potential Potential GDP AD1 1 3 LRAS (potential GDP) SRAS1 At Pt. 1, Actual GDP Actual GDP < Potential Potential GDP Cyclical UnemployUnemployment is present AD1 1 2 At what output level (1, 2 or 3) is Potential GDP > Actual GDP? 3 SRAS Pt. 1 is below the below the trend trend line on the business cycle….and inside the PPC Y = Real GDP 1. Point 1 2. Point 2 3. Point 3 Y = Real GDP SO…….with LR equilibrium in the G & S market: APL SRAS2 2 Pt. 3 is above the above the trend trend line on the business cycle….and beyond the PPC If Actual GDP is at 1 : Potential > Actual GDP If Actual GDP is at If Actual GDP is at 2 : Potential = Potential Actual GDP AD PRS 1 2 Act. = P’tnl Act. GDP 1 At what output level (1, 2 or 3) is Potential GDP < Actual GDP? 3 Act. GDP 3 If GDP is at 3 : Potential < Actual GDP Y = Real GDP 1. Point 1 2. Point 2 3. Point 3 6 3/24/2010 If Potential GDP < Actual GDP, 1. Point 1 2. Point 2 3. Point 3 cyclical unemployment is present in our economy. (DRAW A GRAPH !! ) 1. True At what output level (1, 2 or 3) is Actual unemployment > the NRU? If Potential GDP > Actual GDP, we are at the TOP part of the business cycle. (DRAW A GRAPH !! ) 1. 1. True 2. False 2. False What does LR equilibrium imply? • That producers and consumers CORRECTLY anticipate the correct price level. Why? – Equil. In G&S mkt uses APL & REAL GDP – Since it’s REAL and not nominal GDP … that assumes prices are fixed (prices are not changing & not influencing choices..we’re not considering price changes) considering price changes) – Nothing is putting pressure on prices to increase or decrease. However…. – If D unexpectedly increases (decreases), price unexpectedly increases (decreases) and new profit opportunities arise (or fall). – Thus, movement ALONG the SRAS curve and we are no longer at LR equilibrium. – This is just a TEMPORARY change. Activity 9.2 • Please draw 3 graphs (Label all graphs completely and correctly) : (Label 1. AD and LR & SR AS where potential GDP is > actual GDP 2. The business cycle. Indicate a point “U” that is analogous to your first graph (the point at which the economy is operating) 3. A Production Possibilities Curve. Indicate a point “I” that also shows point analogous to graph “I” that also shows a point analogous to graph one one (the point at which the economy is operating.) The Resource Market Resource Market • Please explain what this economy is like….is it at full employment, less than full employment (if so, what types of unemployment are present), expansion or recession, peak or trough, efficient or inefficient production, etc. 7 3/24/2010 The Resource Market Equilibrium in the Resource Market • The labor market is the largest • • component of this market We “hired” this computer to teach this class Resource demand is derived Resource demand is “derived” demand demand (derived from what that resource helps to produce) – If Dell wants to produce more computers, they need more Labor…they don’t hire labor because they like the workers. They hire labor because they like more computers! If S or D change? What happens to W & Q? S P of resource (wage) ↑ in D Pe1 S P of resource (wage) Pe D Qe Q of resource employed The resource market looks at the relationship between the resource price (wage) and the quantity of that resource employed. employed. If S or D change? What happens to W & Q? S P of resource (wage) in D Pe2 D2 D2 D Qe1 Qe2 D The resource market looks at the relationship between the resource price (wage) and the quantity of that resource employed. employed. If S or D change? What happens to W & Q? S P of resource (wage) Qe2 Q of resource employed S2 ↑ in S Qe1 Q of resource employed The resource market looks at the relationship between the resource price (wage) and the quantity of that resource employed. employed. If S or D change? What happens to W & Q? S P of resource (wage) Pe1 in S Pe2 Pe2 S2 Pe1 D Qe1 Qe2 Q of resource employed The resource market looks at the relationship between the resource price (wage) and the quantity of that resource employed. employed. D Qe2 Qe1 Q of resource employed The resource market looks at the relationship between the resource price (wage) and the quantity of that resource employed. employed. 8 3/24/2010 What is the unemployment rate in Europe compared the in the US? • Historically, the UR in Europe is much • greater than in the U.S. Why? Government safety nets • Very generous unemployment compensation (U.C.) – Belgium (51 percent of salary replaced by U.C.) – France (58 percent) – Switzerland (70 percent) – Denmark (71 percent) – U.S. (25 – 29 percent of wages) Source: http://www.ncpa.org/pub/ba475/ Government safety nets Government safety nets • Very generous unemployment • Very generous unemployment • • compensation More Months of Benefits – U.S. benefits usually 6 months then benefits usually months then expire – Some European Countries: • 40% of previous wages for 2-3 years • 25% of previous wages for 3-5 years compensation More Months of Benefits – U.S. benefits usually 6 months then benefits usually months then expire – Some European Countries: • 40% of previous wages for 2-3 years • 25% of previous wages for 3-5 years • Job Tenure Source: http://www.ncpa.org/pub/ba475/ Source: http://www.ncpa.org/pub/ba475/ 9 3/24/2010 French Labor Riots of 2006… French Labor Riots of 2006… •made it easier for workers under twenty-six years old to be fired.. •It would have allowed employers the opportunity to terminate employment of workers under twenty-six without any reason, with little or no notice, within without any reason, with little or no notice, within their first two years of employment. •Secondary effect of NOT having this bill? High unemployment rates among youthful workers CPE – first employment contract (contrat première embauche ) Google • What happened? Did this new CW 9:4 CW 9:4 Using Using the Fallacy of Composition, please comment on Ms. Huvet’s reaction. legislation pass? What has happened to the UR for French young people? Anything? Nothing? • It passed and then was almost immediately repealed…no chance for it to have much effect on UR for young workers The demand for a resource is: 1. Derived from the demand for the good or service it produces 2. Derived from the foreign exchange 3. 4. market A derivative of the money market th Greater than the demand for goods and services when the economy is at full employment. Loanable Funds Market 10 3/24/2010 Loanable Funds Market • Loanable funds refers to the amount of • • money that is available to be loaned out in the capital market. It illustrates the co-ordination between coborrowers (demanders of LF) and lenders borrowers (demanders of LF) and lenders (suppliers of LF) The LF market is also called the capital market What is the interest rate? • Borrowers pay a price to receive money NOW NOW rather than waiting until they can save that amount. Borrowers are impatient people…they want things NOW. • The interest rate is the price they pay for impatience. • Lenders receive a price to compensate them for waiting to use their money. They are PATIENT! • This market shows the relationship between the The The interest rate is their reward for patience! Equilibrium in the Loanable Funds Market Equilibrium in the Loanable Funds Market price of loanable funds (the interest rate) and the quantity of loanable funds. S = Is the S the BORROWERS or LENDERS? IR (real) IR (real) Who is HAPPY (and therefore want sMORE) when IRs fall? IRe IRe D = Is the D the BORROWERS or LENDERS Qe Q of LF The LF market looks at the relationship between the price of money (int. rate) and the quantity of money demanded (by borrowers) and supplied (by lenders). Equilibrium in the Loanable Funds Market S = Is the S the BORROWERS or LENDERS? IR (real) D = Is the D the BORROWERS or LENDERS Q of LF The LF market looks at the relationship between the price of money (int. rate) and the quantity of money demanded (by borrowers) and supplied (by lenders). Equilibrium in the Loanable Funds Market S = funds available from lenders IR (real) HI IR Who is HAPPY (and therefore want MORE therefore want s MORE) IRe when IR RISE? LOW IR D = funds desired by borrowers Qe Q of LF The LF market looks at the relationship between the price of money (int. rate) and the quantity of money demanded (by borrowers) and supplied (by lenders). Qe Q of LF The LF market looks at the relationship between the price of money (int. rate) and the quantity of money demanded (by borrowers) and supplied (by lenders). 11 3/24/2010 (MA) (Draw a graph!!) An increase in the supply of loanable funds will cause: 1. Interest rates in that market to decline 2. Interest rates in that market to rise 3. The quantity of loanable funds traded to rise 4. The quantity of loanable funds traded to decline. Real interest rate = rate of return + risk 1. Rate of return = compensation to you for not having your money for the length of the loan 2. Risk = chance the money won’t be paid back NOMINAL int. rates = real interest rate + inflation int rates real interest rate inflation Thus, real interest rates ALSO = Real = nominal - inflation When we talked about the effect of a change in the APL on the demand for money, we talked about its influence on interest rates. Now let’s look at the different components Now let look at the different components of of interest rates: Real interest rate = rate of return + risk Review: Things to know about the IR • The nominal rate of interest = the nominal of money money rate of interest – (2 NAMES, SAME THING) • Real IR = Nom. IR – inflation • Nominal IR = Real IR + Inflation • Ex ante vs. ex post inflation • All interest rates tend to move together. • If Nom. IR = 5% Inflation = 2% (ex post or ex ante?) What’s the REAL IR? Activity 9.3 The nominal rate of interest is = to: • Draw a graph of the short run 1. real rate of interest + consumer • 2. 3. 4. • loanable funds market (market for one year loans). Label completely. Show how a decrease in the Supply how decrease in the Supply of Loanable Funds will affect the short run interest rate. Also, as a result of what you explained above, explain what should happen to LONG RUN interest rates. price index Money rate of interest – inflation Real rate of interest + inflation rate of interest inflation Discount rate + federal funds rate 12 3/24/2010 (MA) Ceteris paribus, a decrease in the general level of prices in the U.S. will cause: 1. 2. 3. 4. 5. 6. 7. 8. ↑ U.S. exports ↑ U.S. imports AD curve to shift to the right AD curve to shift to the left ↑Aggregate QUANTITY demanded QUANTITY demanded ↓Aggregate QUANTITY demanded Purchasing Power of consumers to ↑ Purchasing Power of consumers to ↓ If a bank wants to maintain a REAL rate of interest of 4% and inflation is expected to be 3% over the next year, the NOMINAL interest rate on one year loans will be: 1. 2. 3. 4. 5. 3% 4% 1% 6% 7% END of Ch. 9….. Begin: Chapter 10 – Impact of changes in AS & AD Don’t read ALL of ch. 10. ch. ONLY: Beginning of Chapter to bottom of page 220 13 ...
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This note was uploaded on 04/02/2012 for the course ECO 2013 taught by Professor Slate during the Fall '10 term at Florida State College.

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