Macro Chapter 9
An Introduction to Basic
Macroeconomic Markets
7 Learning Goals
1)
2)
3)
4)
5)
6)
7)
List the four key markets in the macroeconomy.
Describe the relationship between the general price
level and the amount of goods and services
demanded.
Describe the relationship between the general price
level and the amount of goods and services supplied in
the short-run and long-run.
Investigate how aggregate demand and supply
determine the price level, output, and employment.
Recognize how the resource market is connected to
the goods and services market.
Recognize how the loanable funds market is
connected to the goods and services market.
Recognize how the foreign exchange market is
connected to the goods and services market.
The Circular Flow Diagram
• Four key markets coordinate the
circular flow of income.
• The resource market coordinates
the actions of businesses
demanding resources and
households supplying them in
exchange for income.
• The goods & services market
coordinates the demand for and
supply of domestic production
(GDP).
• The foreign exchange market
brings the purchases (imports)
from foreigners into balance with
the sales (exports plus net inflow
of capital) to them.
• The loanable funds market
brings net household saving and
the net inflow of foreign capital
into balance with the borrowing
of businesses and governments.
Aggregate Demand for Goods
and Services
What is Aggregate Demand (AD)?
The summation of all goods and services
desired
AD is the relationship between two
variables: amount of goods desired and
the price level
Graph of AD:
Watch content video: Macro Chapter 9aggregate demand
Q9.1 For an economy, aggregate demand equals
1.
2.
3.
4.
consumption plus investment plus government
purchases plus exports.
consumption plus investment plus government
purchases plus (exports minus imports).
consumption plus investment plus (taxes minus
transfers) plus (exports minus imports).
consumption plus investment plus government
purchases plus (imports minus exports).
Aggregate Supply of Goods
and Services
What is Aggregate Supply (AS)?
The summation of all goods and services
offered for sale
AS is the relationship between two
variables: amount of goods offered for
sale and the price level
When thinking about AS, you MUST
distinguish between the short run and the
long run
Graph of SRAS:
Watch content video: Macro Chapter 9aggregate supply
Why is SRAS upward sloping?
In the short run, many resources prices
are fixed
An increase in the price level increases
profits so firms are willing to make more
goods
Graph of LRAS:
Why is LRAS vertical?
In the long run, people fully adjust their
behavior to account for price changes
Resource prices are flexible so an
increase in the price level does not change
profits
LRAS is determined by technology,
resources, and efficiency; NOT by prices
Q9.2 In the context of aggregate supply, the short
run is defined as the period during which
1. some prices are set by contracts and cannot be
adjusted.
2. prices can change, but neither aggregate supply nor
aggregate demand can shift.
3. individuals have sufficient time to modify their behavior
in response to price changes.
4. quantity changes cannot occur in response to changes
in relative prices.
Q9.3 In the context of aggregate supply, the long
run is defined as the period during which
1. some prices are set by contracts and cannot be
adjusted.
2. prices can change, but neither aggregate supply nor
aggregate demand can shift.
3. individuals have sufficient time to modify their behavior
in response to price changes.
4. quantity changes cannot occur in response to changes
in relative prices.
LRAS is the economy’s full
employment rate of output!!
LRAS = potential GDP
The natural rate of unemployment occurs
at LRAS
Equilibrium in the Goods and
Services Market
Since we have SRAS and LRAS, we will
have short run equilibrium and long run
equilibrium which can be different
equilibrium points
Graph of equilibrium points:
Watch content video: Macro Chapter 9equilibrium points
Compare Models:
AD-AS_bus-cycle.pdf
Key Points
When the economy is in long run
equilibrium:
– (1) actual GDP = potential GDP
– (2) actual unemployment rate = natural rate of
unemployment
– (3) SRAS, LRAS, and AD are all equal
Use this graph to answer the next
questions.
LRAS
P level
SRAS
AD
Y
(1)
(2)
(3)
Q9.4 (MA) Which of the following statements are true?
1. At point (1) actual GDP is greater than potential GDP
2. At point (1) actual GDP is less than potential GDP
3. At point (1) actual unemployment is greater than the natural rate of
unemployment
4. At point (1) actual unemployment is less than the natural rate of
unemployment
5. At point (3) actual GDP is greater than potential GDP
6. At point (3) actual GDP is less than potential GDP
7. At point (3) actual unemployment is greater than the natural rate of
unemployment
8. At point (3) actual unemployment is less than the natural rate of
unemployment
Key Points
When the economy is in an expansionary
phase:
– (1) actual GDP > potential GDP
– (2) actual unemployment rate < natural rate of
unemployment
– (3) short-run equilibrium is greater than
average; greater than long-run equilibrium
Key Points
When the economy is in a recessionary
phase:
– (1) actual GDP < potential GDP
– (2) actual unemployment rate > natural rate of
unemployment
– (3) short-run equilibrium is less than average;
less than long-run equilibrium
Resource Market
Think primarily of labor as a resource
When businesses want to produce more
goods, they will need more labor (resource
demand increases)
Q9.5 Other things constant, an increase in
resource prices will
1. increase the demand for goods and services.
2. increase the cost of producing goods and services,
which will lead to a higher price level.
3. reduce costs and improve profit margins, which will
lead to an increase in aggregate supply in the goods
and services market.
4. cause the natural rate of unemployment to rise.
Loanable Funds Market
The loanable funds market is the
coordination between borrowers
and lenders
Borrowers demand funds
Lenders supply funds
The interest rate is the price:
– Borrowers pay a price to receive money now
– Lenders receive a price to wait
Interest Rates:
money interest rate = nominal interest rate
real interest rate = money rate – inflation
The money, or nominal, interest rate is the
only rate you can put in writing
The real rate will change, depending on
inflation
Exercises
If the real interest rate is 3% and the
nominal interest rate is 5%, what is
inflation?
If the nominal interest rate is 7% and
inflation is 6%, what is the real interest
rate?
Q9.6 Which of the following is the most accurate
statement about real and nominal interest rates?
1. Real interest rates can be either positive or negative,
but nominal interest rates must be positive.
2. Real interest rates and nominal interest rates must be
positive.
3. Real interest rates must be positive, but nominal
interest rates can be either positive or negative.
4. Real interest rates and nominal interest rates can be
either positive or negative.
Foreign Exchange Market
Suggestion
Read the following sections in Chapter 19:
Foreign Exchange Market, p. 378-380
Balance of Payments, p. 387-394
Watch Video: Dodgeball-Canadian foreign
exchange (just for fun)
Foreign Exchange Market
Dollar price
(of foreign currency)
S
(exports + capital inflow)
Depreciation
of dollar
P1
D(imports + capital outflow)
Appreciation
of dollar
Q
Quantity of
foreign currency
Dollar price (of foreign currency) = how many dollars
you must give up to get foreign currency
Another way to think about foreign
exchange
Dollar price = $$ / foreign currency
Example: $1 / £1 then $0.50 / £1
Equivalently, $1 / £1 then $1 / £2
– $1 now buys twice as much in England
Foreign exchange terms:
The dollar appreciates when you need
fewer dollars to receive the same amount
of foreign currency (or, equivalently when
you can buy more foreign goods with the
same $1)
– The dollar is referred to as strong or
strengthening
– Americans import more, export less
Foreign exchange terms:
The dollar depreciates when you need
more dollars to receive the same amount
of foreign currency (or, equivalently when
you can buy less foreign goods with the
same $1)
– The dollar is referred to as weak or
weakening
– Americans import less, export more
If the dollar appreciates against another
currency, then that currency depreciates
against the dollar
Some exchange rates:
US-Japan
US-Euro
US-weighted index
US-China
Key relationship:
A trade deficit (imports > exports) requires
an inflow of capital (foreigners purchasing
US financial and real assets > Americans
purchasing foreign assets)
A trade surplus (exports > imports) allows
for an outflow of capital (Americans
purchasing foreign assets > foreigners
purchasing US assets)
Trade Balance
Capital Inflow
Capital Outflow
Q9.7 (MA) If the dollar price of the English pound
goes from $1.75 to $1.50, then
1.
2.
3.
4.
the dollar has appreciated against the pound.
the dollar has depreciated against the pound.
the pound has appreciated against the dollar.
the pound has depreciated against the dollar.
Q9.8 (MA) If the dollar price of the English pound
goes from $1.75 to $2.00, then
1. Americans will find English goods cheaper.
2. Americans will find English goods more
expensive.
3. The English will find American goods cheaper.
4. The English will find American goods more
expensive.
Question Answers
9.1 = 2
9.2 = 1
9.3 = 3
9.4 = 2, 3, 5, 8
9.5 = 2
9.6 = 1
9.7 = 1, 4
9.8 = 2, 3